Full text of "Role of accounting in the economic development of the modern State"

THE ROLE OF ACCOUNTING IN THE ECONOMIC
DEVELOPMENT OF THE MODERN STATE

KENNETH SAMUEL MOST

A DISSERTATION PRESENTED TO THE GRADUATE COUNCIL OF

THE UNIVERSITY OF FLORIDA

IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE

DEGREE OF DOCTOR OF PHILOSOPHY

UNIVERSITY OF FLORIDA
1970

UNIVERSITY OF FLORIDA

3 1262 08552 2018

ACKNOWLEDGMENTS

This work is the result of many years cf stud^'' and
reflection J and acknowledgment is due to those scholars
and teachers wliose ideas I have used v«7ithcat stint, in-
cluding some with whom I have had occasion to differ,

I am particularly grateful to Dr. R. U. Elodgetc,
who not only was kind enough to act as ChairiT^an oi r.y
Supervisory Cor.u,-LX htee , but also has been a repeated bource
of enlightenment, enccurageiiient and helpful criticism. I
am al!?o grateful to Dr. S, C. 'iu for his advice and asr-isc-
atice, and to Dr. C ., H. Donovan and Dr. C, A. Matthev/i;. for
their support, and to all of these for a::>-i.ng -ac. reT.bers
of my Superv.i. ="ory Coirnii ttee .

Finally, I would like to ackno'.";lt:dcr= a moral debt
to Dr. Williard S. Stone, without v;hose guidance, friend-
ship and support this work could not have b.een completed,
and an intellectual debt to Dr, l^lorasa Mey, Emeritus
Professor of Business Economics j.n the University of
Amsterdam, without \/hcse exam.ple and precept, it would not
XI a. v e been undertake n. .

TABLE OF CONTENTS

Page
ACKNOWLEDGMENTS

T "1

LIST OF FIGURES

* Vx

ABSTRJlCT , ^^^^

Chapter

I . INTRODUCTION 1

II . ACCOUNTING AND ECONOMICS . = .........,.., IR

Accounting Methodology 18

Definition of the Field . . . , IS

Aoccunting Distinguished fr-om

Statistics ,,,,., 22

The Uses of Aaoounting 24

Economists ' Uses of Accounting ....,..,,., 30

Macro-economics = . . . 31

Mici'o-econoTnics 35

III. THE SOMRART PROPOSITIONS REVISITED 47

Somhart and the Rise of Cavitulism ....... 48

The Origins of Capitalis;n 43

The Business as Accounting Entity 51

Yamev and the Sombart Provositicns 53

The Sombart Hypothes is Brought

Up-to-date / 63

Sombar-t's Assumptions Criticized 53

An Alternative Hypothesis 69

AooouYiting^ Planning ancL Coritrol 75

IV. THE FOUNDATIONS OF ACCOUNTING THEORY 83

The Economic Theory Model of the Firm .... 84

The Financial Model of the Firm 103

The Cybernetics Model of the Firm 114

Conclusion 121

J. 11

TABLE OF CONTENTS — Continued

Chapter Page

V. AN ACCOUNTING THEORY OF THE FIRM 129

Th.e Organization and Processes of

Production . . , . 130

Iy%vestment and Capital - 130

EquiTpynent y or Investment in

Capaciti/ 135

i'iyiance and Workino Capttal- » . . 138

Operations J or Costs and Production. ..,. 141

Sales Revenue^ or Distribution 146

The Production Process Accounting

Model of the Firm 150

The Accounting Model Applied to the

Nonprofit Firm - • • 156

Valuation and Government Revenue ....... 156

The Nature of "Money" and

"Valuation" 164

Coyiclusion 1*57

1 '\

VI . SOCIAL ACCOUNTING 1 /

History of Social Accoy-tnting 173

The Soviet System 179

The U. S. System 1B3

So c io.l A-Coountina Cv i tico, 1 1 y

Appraised 187

Conclusion 198

VII. THE FRENCH ACCOUNTING EXPERIMENT 206

History and Organization 207

The Period 1947-62 213

p-yogress Since 1962 215

The Psychological and. Technical

Problems 219

Psychological Problems 219

Technical Problems 222

Conclusion 226

VIII. ACCOUNTING THEORY AND ECONOMIC DEVELOPMENT .. 229

A New Theory of Accounting 231

Value and Addi tivi ty 234

The Importance of Accounting in

National Planning 240

Concliision = . . . 243

TABLE OF COWl:EirXS~<:ontinued

Page

APPENDIX . ,.,.....,... 247

BIBLIOGPJ^PHY 267

BIOGRAPHICAL SKETCH 281

LIST OF FIGURES

Figure Page

1. Ricardlan Model of the Firm . 88

2. Static Price Theory Model cf the Film 90

3. Managerial Decision Model of the Fiim ....... 91

4. Model of the Firiri 105

5. Model of the Firm « 106

6 , Cash Flow Statement 110

7 . Information System . , . c ...... , 117

8. Organization cf a Business in Relation to

Its OparatJ.ng Requirements , , 147

9. The Accounting Model of the Firm 151

10. A National System of Social Accounts 183

11. Proposed Model of the Social Product

Account . o ............ 197

v:.

Abstract of Dissertatior. Presented to the Graduate Couiici].
in Partial Fulfillment of the Requirements for the
Degree of Doctor of Philosophy

THE ROLE OF ACCOUNTING IN THE ECONOiyilC DEVELOPMENT

OF THE MODERN STATE

Kenneth Samuel Most

June, 1970

Chairman: Ralph H. Blodgett
Dexjartment: Economics

The aixn of this study is to determine why, how aiid
to what extent the methodology of accounting has a part to
play in the eccncrdc development of the modern state. It
is argued that accounting is more usefully seen as a plan-
ning methodology f che control function being derived from
the planning function.

The importance of abandoning unnecessary assumptions
is emphasized, in particular, the assumption of profit-
laaxim.Lzing behavior which underlines tradi.tional work in
accounting theory. A new accounting theory i5 based on
the account and the identification of an acceptable set of
beliefs concerning the real v/orld to which it must be
related. Criticism.s of accounting emanating from accountants

Vll

and economists are stated in ordar to specify the objections
which a new theory of accounting must overcome.

The "Somtjart Propositions" are critically exam.ined,
particularly in the light of Yamey ' s attacks on them. An
alternative hypothesis to Sornbart's view of the rise of
capitalism is put forv/ard, which permits the restatement
of the Sombart propositions in support of a theory of ac-
counting as a planning and control methodology. A trans-
lation of the relevant passages from Sornbart's Dsr Modarne
Kavital-isnus forms an appendix to the study.

The foundations of c;.ccounting theory are shown to
rest upon the assumption of price theorists that investment
and prodiaction can be studied from the consumer pole. Many
theorists assume that behavioral factors relevant for a con-
sumer model of the economy are equally relevant for a pro-
ducer model, in spite of the observation that Say's law no
longer applies. The waakness v/hich results from this error
is the absence of a usable model of a production ecGncm>y,
in particular, of acceptable beliefs about the organization
and processes of the firm. An alternative model derived
from corporation finance is examined; this is shov/n to be
based on the assumipcion of a nonexistent physical "flow"
of liquidity. The cybernetics models of the firm are like-
wise rejected, on the grounds that the only beliefs about
reality v/hich they incorporate are, in fact, images of the
com.puter.

viii.

An accounting model of the firm is presented. This
model is shown to have great generality, and to be appli-
cable to nonprofit firms, such as government agencies, in
both the planning and control phases.

The two principal approaches to social accounting
are examined in the contexts of the U. S. and Soviet systems;
these are seen to display the sam.e defects as are found in
business accounting theories. The accounting model of the
firm is shown to be adaptable to the production economy of
a nation, leading to the conclusion that national prcduct
and national income are distinct concepts.

The French experim.ent in using accounting explicitly
as a social planning and control instrument xs described
and evaluated. It is shown that: the model underlying the
French experiment is essentially the same r.s the accounting
model presented in this study.

In conclusion, conventional criticisms of accounting
are refuted. The error involved in viewing valuation as
measurement, akin to those measurements used in the physical
sciences; is discussed in relation to the additivity of
values, and it is asserted that, since all values are sub-
jective, objectivity lies in interpersonal agreement and
not in existential phenomena. The study points the
direction in which a developing modern state would be able
to move with the aid of accounting miethcdology ,

CHAPTER I
INTRODUCTION

The aim of this study is to determine why, how and
to what extent the methodology of accounting has a part to
play in the economic developm-ent of the modern state. It
will not be necessary to assume for this purpose that ac-
counting methodology plays a principal part in such develop-
ment, or a major one, nor need we devote attention to those.
other methodologies which have a claim to be considered in
this context, such as the Domar-Harrod growth models, the
econoraetric rfiOdels of Klein and Tinbergeo , or the models of
"optimum theorists" such as Von Neumann, Samuelson and
Morishima. * It is not even necessary to exclude the rele-
vance of simple m.acro-ecc>noraic models of the so-called
"classical" and "Keynesian"' types. Each of these method-
ologies is potentially useful to the analyst and planner,
who will nresum.ablY consider all available mathematical
iTiodels, including those of linear and nonlinear programming,
simulation and probabilistic strategies, 3.nd a variety of
others both heuristic and stochastic, to assist in the
processe:; of planning and control. None of these v/ili be
examined hare, and we shall be concerned exclusively with
accounting.

- ? -

It is coi-nriion knowledge that accounting has flourished
in those states we categorize as prosperous, and that, as
their prosperity declined, so did their accounting. Typical
was the situation of the pre-Christian Chaldeans and Greeks,
who left many records of their wealth and economic trans-
actions in a form which can be recognized as accounting,
together with descriptions of their accounting and auditing
methods. The post-Christian dark ages, which began when
Goths and Vandals disrupted established patterns of inter-
national trade, drove this tradition underground; it emerged
only after the Crusades reopened the old trade routes to the
East. Modern accounting dates from the Renaissance wnich
the Crusades made possible.

Students of the history of accounting have tended
to see its role in ancient and medieval tiiiies primarily in
terms of the stewardship of wealth. According to this
hypothesis, the creation or accumulation of v/ealth leads
to the formation of institutions for its preservation, and
with them goes a responsibility to account for the prcccesses
whereby the wealth is administered. This hypothesis under-
lies the various "investor" theories of accoiintina — t.he
proprietary theory, the entity theory, the fund theory, and
so on. As a hypothesis, it purports to explain the develop-
ment of accounting at the level of the institution within
the stats, the state itself, and even internationally as,
for exaraple,. in balance of payments accounting.

- 3 -

There are, however, a number of modern instances of
political recognition that accounting may have a significant
role to play in the process of economic development. Per-
haps the most striking is the French National Accounting
Plan follov/ing the second World War. Prior to that v/ar the
French people had enjoyed what was in some ways the highest
standard of living in Europe, but they ended it with their
economy at a standstill, and much of their capital destroyed,
It v;as evident that any postv;ar government would stand or
fal]. on its ability to restore per capita income and con-
sumption to their prewar .levels, in a fairly short space of
time. One of the first legislative acts of the postwar
French government was to establi.sh a llation^l Office of
Accounting in the Ministry of Finances, v-hich proceeded to
regulate the practice of the profession of accounting and
to lay down a framework for accounting at the macro- and
micro-economic levels, with the aim of strengthening its
functioning in government, industry and trade. Similar
tendencies, albeit less marked, can be seen in Holland,
Greece and Japan and other countries attempting rapid
economic development; it is also noteworthy that some
former British colonial and ether territories are travel-
ling the same road,- for example, Singapore and Malaysia.

It appears that the stewardship roJe may play a
considerably less important part in these phenomena than

- 4 -

the traditional theory v;ould imply, and that accounting as
a tool of planning and decision-making, which historians
suppose to be a relatively modern development, should be
given precedence in any theory of accounting. David F.
Linowes recently commented^ on his experiences during visits
to three developing nations . He found that leaders in those
countries envisaged a more extensive role for accounting than
would be recogni-'::ed in the United States. In particular, he
drew attention to the viev; that accounting should be part of
the central planning process which such nations find essen-
tial to rapid expansion of industry end agriculture, a viev?
which can also be identified in the unified budgetary systems
of the centrally planned economies' of Eastern Europe. Linowe;
referred to his ov;a participation, under the auspices of the
U. S. State Department or the United Nations, in missions to
Turkey, Iran and Pakistan, aimed a': establishing accounting
professions in those countries.

It was brought home to him in this work that the
scope of accounting had to be broadened to include the meas-
urement of available resources and control of their use.
In developing countries, the problem of providing planners
with adequate information became critical, and could be
resolved by the use of accounting data; hence the urgency
and importance of creating an accounting profession. A
similar conclusion was reached bv Enthoven as a result of

- 5

his experiences with the Investment Department of the
International Finance Corporation betv/een 1964 and 1967."
Enthoven starts from the investor theory of accounting and
ascribes the grov/th of accounting in modern times tc its
usefulness for showing the effects of changes in wealth.
Ke sees cost accounting as a separate and recent development
which culminates in "management accounting," and the second
of the articles cited describes the many ways in which
management accounting can be used as "economic development
accountancy . "

We see from this the paradoxical situation that
greater importance is placed on accoxinting for poor and
developing states than for vjealthy, es tablislied ones, and
this observation throv;s doubt lapon the validity ot those
theories which treat accounting as primarily a record-
keeping and reporting function. We shal'i therefore advance
an alternative hypothesis, namely, that the methodology of
accounting constitutes a conceptual framework, of the nature
of a nonexplicit behavioral model of a closed system, designed
purposely for planning and control functions rather than in
the light of ca-allactic or custodial needs.

In Chapter II we shall attempt tc delineate the
field of accounting and establish its links with economic
science; in doing this we shall draw attention to con-
flicting views concerning the usefulness of accounting.

6 -

Chapter III will be devoted to a critical evaluation of the
Sombart proposition, that accounting was a necessary factor
in t?ie rise of capitalism following the European Renaissance
in the thirteenth and fourteenth centuries, which has ob-
viuus ielevctiiuu Lo our hypoLhesis. In Chapter IV we shall
identify the assumptions which underlie som.e of the more
significant contributions to accounting theory, and the
reasons why it has proved impossible to build a consistent
theoretical structure upon them; in Chapter V we shall exam-
ine another model, which is capable of reconciliation v;d th
accounting theory and practice, which is consistent with
the relevant parts of economic theory, and which supports
the planning hypothesis. This chapter will also show hov/
the model can be applied in the important area of control
of public expenditure. In Chapter VI we shall discuss the
implications of the model for social accounting and the
representation of the national income. Chapter VII will
describe the French experience v;ith a uniform chart of
accounts,- and in Chapter VIII we shall state the conclusions
we derive from this study which may be of interest for the
economic development of the modern state.

We shall endeavor to make clear our assumptions at
appropriate places throughout, but a preliminary word on
the general nature of the problem involved may be apposite
here. The contemporary taste for an axiomatic approach to

/ -

the development of theories in the behavioral sciences has
had several unfortunate results. In the first place, we
see a tendency to assume that the required axioms are
relatively few in number; this assumption seems to have
made its way into accounting theoi'V from ef^onomic theory,
and into economic theory from the physical sciences. Quite
apart from the question of scientism, this assum.ption does
not appear necessary for the conduct of our inquiry, and we
shall not rely upon it.

In the second place, we may note the rise of
"methodological non-.inalism, " a term coined by Karl R. Popper
to designate the assumption that usefulness in prediction
is the criterion by which to evaluate an assumption.** This
viewpoint has been adopted by Milton Friedman,^ who argues
that an assumptiovi is admissible if it leads to conclusicns
which predict succitsfully better than 50'a of the observa-
tions for which it. is used. Friedman provides an illus-
tration of the use of such an assumption in the statement.
that "the distance travelled by a falling body is equal to
one-half the gravitational constant multiplied by the square
of the time the body falls," -which depends upon the unreal-
istic assumption that the object is falling in a complete
vacuum.

We shall distinguish between methodological
assumptions of this type, resembling the oetevis parih-us

- 8 -

assumption used so successfully in economic theory and the
"going concern" assumption of accounting theory, and
behavioral assumptions, particularly those which involve
attributing behavior to concepts. The former are intrin-
sically equal, and choice between them can only be made on
the basis of usefulness; scientific progress is a continuous
abandonment of assumptions which have outlived their use-
fulness. Behavioral assumptions, on the other hand, are
always true in the sense that corresponding behavior can
be observed in people, yet their usefulness can never be
demonstrated.^ To say that businessiaen are motivated to
maximize profits, or wealth, d.s dem.onstrably correct, no
matter how these concepts are defined, yet this is quite
inadequate for explaining actual decisions unless reduced
to a tautology. To say that consumers attempt to m.aximize
utility leads to a comparable impasse. To speak of public
expenditures or business costs "behaving" in certain ways,
by contrast, is pure anthropomorphism.

We shall adopt the viewpoint that behavioral
assumptions are not intrinsically equal; some assumptions
are better than otners. Not only must they be empirically
demonstrable, but it must also be shown exactly how they
affect any result obtained. We shall therefore not start
with assumptions of utility- or prof it-m.aximization j the
specific reason for the latter v/ill be explained later in

- 9

this chapter. Nor shall we make all the other assumptions
economic theorists consciously incorporate in their prj.ce
theory, v/hich underlies most formal work in economics and
on which accounting theorists, often unconsciously, base
their systems of ideas. We shall assume the fundam.enta-l
institutions of private property, a degree of freedom of
enterprise, and the relatively unrestricted operation of
a raonetary system. We shall also assume a scarcity of means
relative to ends, as this lies at the base of all value
theory, and take as given the distribution of capital and
income and a large measure of econom.ic stability. All of
these can be readily identified as features of the modern
"mixed economy" state, and, indeed , we shall attempt to
show that some of the problems which arise when conmaunist
states turn to accounting methodology can be atLributed to
the absence of one of these features.

We shall not assume certainty, pure competition,
full employment, homogeneous functions, discrete time periods
or products or factors of production, or diminishing returns
to factors or to scale, nor shall we require assumptions of
constant prices, resources, incomes, tastes, products,
, capacity, technology, taxes or subsidies. In particular,
we shall have to discard the assumption that everything
happens instantaneously, for time, as a mental construct,
enters directly into our field of observation and affects

- 10 -

our results. We shall make an assumption of rationality,
in that ws shall require actions to conform to the physical
and institutional constraints perceived by us, and to any
postulated objectives of the businessman, civil servant or
other decision maker. It is hoped that this will not lead
to the teleological assumption of rationality which Veblen
criticized so severely, and which the foregoing discussion
v/as designed to avoid.

It may be argued that the failure to base our study
on more rigorous lines lays us open to the charge of over-
generalization. This issue has been faced before by the
French economist J. Marchal:

In attempting thus to reconstruct price theory on a
more realistic basis, by taking into account all the
complexities of human nature, by classifying according
to the form and structure of markets, by introducing a
real time element instead of an abstraction, one runs
the indisputable risk of producing a less rigorous
construction, on less pure lines, and one which may
disappoint all those who have been seduced by the
simplicity and perfect3.on of the classical analysis.
But one can hope, at the same time, to produce a theory
which connects better, not only with the theory cf
general equilibrium and the theory of business cycles,
but with all that we know of systems and of structures.'

Abandoning a profit-maximization assumption will

be particularly distressing to American (and Australian)

accounting theorists. With the possible exception of one

or two works on economic accounting, ail of tlie v;ritings

of these theorists assume that the centerpiece of their

theory must be the corporate financial statem.ents, and that

li-

the pi-incipal aim of accountants is the measurement of
business income. We do not share their view of the im.por-
tance of the corporate financial statements; just as regular
political journalism in England began in the Civil Wars,
when King and Parliament competed with one another in
writing, so the financial statement, as we know it, originated
in the struggle of the nineteenth century industrialist to
finance his manufacturing plants. His need for. publicity
in this connection was hardly less acute than that served
by the political journalist in the other. But a newspaper
is not literature, and a balance sheet, even with a profit
and loss account attached, is not accounting, and any attempt
to formulate a theory of accouncirg which requires such an
assumption is virtually certain to fail. The manner in
which this failure has so far manifested itself will be
described in due course; at this point v7e shall restrict
ourselves to identifying the underlying cause.

The logical error m.ade by both accounting and
economic theorists is to confuse the problems of production
with the problems of consumption. A preliminary observation
establishes these two poles of economic activity, which
have noneconornic foundations and to which all actions must
be traced if economic phenomena are to be analyzed for
purposes of prediction and planning," The typical image
of an economy looks like this:

~ 12 -

Factor Markets

Services

Payments

Product Markets

Having taken this first step, the theorist proceeds
to conduct his analysis from the standpoint of one of the
poles, namely, consumption, and the motivations of producers
and consumers are found to manifest themselves in essentially
consumption terras — maximize income for the former, satis-
factions for the latter. There is no reason, however, why
the motivations of these two classes of activity must be
expressed in terms relevant to one of them; otherwise put,
there is no social mechanism, at the present time at least,
which can ensure that production and consumption are
simultaneously determined. Say's law does not apply.
That they may, and even must, be brought into some kind of
a relationship through time and, in a long enough time
period, can be brought to equality, is admissible, but the
essentially distinct decisions involved must be treated
separately in any formal analysis.

- 13 -

If we were to concern ourselves with behavioral
assumptions, we should be obliged to postulate that the psy-
chological forces underlying production decisions are dif-
ferent from the psychological forces underlying consumption
decisions, because the producer seeks to cater for the
satisfactions of others, while the consumer seeks only the
satisfaction of self. This would permit the sam.e individual
to behave differently according as he was acting in his
role of producer or consumer;^ it would also help to underpin
the argument which is conducted in Chapter VI in favor of
a restructuring of the national income accounts. The dif-
ferent functions of money, which tend to confuse the mone-
tary theorist who thinks in consumptj-on term.s , can be
readily fitted into a conceptual framework v/hich sses some
of them as producers' functions and others as consumers'.
We shall not pursue this line of inquiry tiere, as v/e find
it unnecessary to rely on behavioral assum.ptions of this
kind; we simply observe that some individuals undertake to
produce goods and services to be consumed or otherwise
utilized by others. Nevertheless, v/e cannot resist the
temptation to draw attention to a similar statement which
has recently been made by a noted behavioral scientist.

UrwiCiC has reconsidered the basi.s of Douglas
McGregor's contrasting theories of human behavior, known
as Theory X and Thevory Y, X assumes that man is resiscant

- 14 -

to changes, and that he will only implement managerial
decisions if rewarded or punished for refusal, Y assumes
that man is basically goal-oriented, and that he v;ill
support changes if they can be seen by him to help him to
achieve his goals. Urv/ick points out that m.an as a. consum.er
is not eillergic to changes, but as a producer he is more
cautious, because of a fear of losing the source from which
his consumption flows. The trend of modern life is to
separate the functions, not. only in production terms, but
also in social situations — ^men and unmarried females pioduce,
wives and children consume. The whole economic process con-
sists in relating the behavior of the individual consumer
to the behavior of the same individual as a producer or
distributor. This he calls Theory Z, and he demonstrates
by means of a diagram the points aL which a lai-^k of coui-
munication may make itself felt.^°

It is easy to see how the income (= profit)
maximization assumption, v;hich was found necessary in
order to explain production in terms of consumption, led
accounting theorists to seize on income determination as
the prime objective of accounting; the observation that
the bulk of accounting work lay in the comriiercial area of
production and distribution provided an additional support
for this hypothesis, and the inconvenient fact that ac-
counting had its origins in the public sector was suppressed,

- 15 -

or treated as an oddity. The choice of income determination
as a prime objective was particularly unfortunate since
business net income (in this context, profit) is a residual,
the result of offsetting value movements in two opposite
"^ir^cticns and as such inherently jnca^~'able of analvsis.
In this study we shall substitute the production concept
of profit for the consumption concept of income wherever
the context calls for its mention, and refrain from a
profit-maximization assumption, not because of the demon-
strated difficulty of making such a construct operational,^^
but simply because it is unnecessary for explaining the
role of accounting in economic development . ■^ ^

The philosophy of this study has been expressed in
the follovzing words:

An accounting system is not a failure if it does not
present data in a way that will most please everyone,
but it is a failure if its accounts do not enable the
greater part of persons interested in them to glean
facts for a variety of problems.''^

It is one of the main objects of this study to show

that it is possible to formulate a theory of accounting

which is equally relevant to financial accounting, managerial

accounting, tax accounting, social accounting and. corporate

accounting, and v;hich is equally applicable to all types of

institutions, public or private, to human individuals and

to households. In this v/ay, the complexity of modern

economic life can be seen to be manageable with the help

of the accountant.

NOTES

1. J. R. Hicks, Capital and Growth (New York and Oxford,
1965); reviev7s and compares these models.

2. "The Role of Accounting in Emerging Nations," The
Journal of Aceountanay , Vol. CII (January, 1969) ,
p. 18.

3. Adolf J. H. Enthoven, "Finance and Development,"
International Monetary Fund, Vol. 6, No. 2 (June,
1969), pp. 16-23 and Vol. 6, No. 3 (September, 1969),
pp. 24-29.

4. The Open Society and Its Enemies (Princeton, 1950).

5. The Methodology of Positive Economics (Chicago, 1953).

6. For a discussion on this point, see Gunnar Myrdal, The
Political Element in the Development of Economic Theory
(Harvard, 1955), pp. 200--201.

7. J. Marchal, he Meaanisme des Prix (Paris: Librairie
des Medicis, 1948), p. 15 (our transl.).

8. J. A. Schumpeter, The Theory of Economic Development

(New York: Oxford University Press, 1961), pp. 4-5.
(First pub. 1934. )

9. In private conversations with the author, a psychiatrist
has observed that one of the common features in serious
marital disputes is the presence of two fundamentally
distinct attitudes to money. The v/ife sees in money a
means of payment, the use of which is to acquire con-
sumption goods and services; the husband sees it as a
unit of measure which is useful in planning the pro-
duction of goods and services for future consumption,
often by the wife.

10. L. F. Urv/ick, "Theory 2," Advanced Management Journal,
Vol. 35, No. 1 (January, 1970), pp. 14-21.

11. R. N. Anthony, "The Trouble with Profit Maximization,"
Harvard Business Review, Vol. 38 (Nov. -Dec, 1960),
pp. 126-134.

- 16 -

17 -

12. It is interesting to note that Chanibers.- with whora we
shall find ourselves in marked disagreement, identified
this problem without addressing himself to its solution.
He wrote, in Accounting ^ Evaluation and Economic Bt-:~
havior (New Jersey: Prentice-Hall, Inc., 1956), at

p. 66: "The goals of production and consumption are
different in kind, and entirely different modes of
behavior may be observed as a man's calculations shift
from one role to the other. . . . Entities engaged in
trading, manufacturing, and ancillary operations m.ay
thus be deemed to have no consumer role."

13. John P. Fov/elson, Eoonomia Accouming (New York:
McGraw-Hill, Inc., 1955), p. 10.

CHAPTER II
ACCOUNTING AND ECONOMICS

Adoounting Methodology

Definition of the Field

For the purpose of this study 3t is not necessary
to define "accounting" narrowly. In accounting, as in
other fields of empirical inquiry, we analyze the relations
between observable data,^ and we shall assur.e that in this
field we find a number of problems thro/zn together for
convenient reference, the cormaon feature being the use of
a particular methodology to solve them. In particular,
we do not assume that "double-entry" is a necessary element
of accounting, since v;e postulate the fact, that accountants
make as many entries as are required by the purposes of
their analysis; the x^op^l^r preoccupation with double-entry
bookkeeping is a mere historical survival.^ It also leads
to unfortunate metaphysical speculations, such as Mattessich's
treatment of the "duality principle."- No one, apparently,
disputes the inclusion of single-entry accounting in the
field.

A method may be defined as a family of models, and
a model as a construction in which selected elements of a
state or process which we desire to investigate are combined

- 13 -

- 19 -

in order to study their interrelations and interactions.'*
The account is a model in this sense, being a construction
in which movements of values are combined; the concept of
"value" will be examined in more detail subsequently, and
here it v^ill suffice to say that we mean by this term a
representation in money. The bilateral form which we are
accustomed to think of as an account, since it is invariably
used for illustrative purposes, is no m.ore essential to the
model than the wheel to transportation, but it is useful
for didactic and expository reasons.

The characteristic features of the account are:
the name of the value, the description and dimensions of
a two-way flovc' (in and out, or from and to) and the dates
of the components of this flov:. By arranging thoce elements
in a significjint fcrin v/e can see L:he result of the flov/
th rough time.

Name of the account

Date Flow in (frorrO Jimount ] Date Flow out (to) Amount

The quantitative representation of the result of
the flow is called the halapoe; it may be < 0. There is
no particular significance to the fact that inward flows
are shown on the left-hand (debit) side and outward flows
on the right-hand (credit) side, except that consistency
calls for a rule, and the one in use appears to offer
practical advantages.

- 20 -

The model has the virtue of ubiquity; it can be used
at ail levels of aggregation. Just as we can imagine an
account for a particular economic value, so we can imagine
an account for the totality of values of a selected kind,
or even for all values moving within ^n i dpntif i abl p
economy. This feature permits both aggregation and disag-
gregation to be performed within a logically consistent
framework .

In order to construct an account we require a
written language, a model of time, a currency of account,
the technique of addition and one or more valuation models.
The first four present no special problem; we can use any
language, the universal calendar and any currency, even
an artificial measure like the Egyptian shat which had no
circulation. The ciioice of valuation model it; more dif-
ficult, since it brings us face to face with the problem
of value. The Aristotelian concept of an equivalence of
V7hat a man gives and receives is clearly attractive in this
context, and we shall see that accounting theorists and
practitioners have relied on it to a great extent. It has
long been realized, however, that since "both parties to
an act of barter or sale must necessarily gain by it . . .
there can be no equivalence between the 'subjective' or
utility values of the goods exchanged or between the good
and the money paid or received for it."^ We can agree with

- 21

Schumpeter that "metaphysical speculations about objective
or absolute value" can be dispensed with. A valuation
model is defined here simply as a construction which per-
mits quantitative representation in money, that is, the
assignment of currency units to an object; thus, the ob-
jective value of a good or service is "the magnitude defined
and nothing else."^

We should note at this point, however, the cost
theory of value attributed to Duns Scotus and St, Thomas
Aquinas, under which the "just" price of a thing is equated
with its competitive common value and called its "cost."
The term, "cost" has at least three different meanings in
accounting; it. may mean depending on. tne context, value in
exchange, value in use, or necessary sacrifice. The same
situation has arisen in ecoiiomic theory; the "jur^t price"
becomes variously a qi^antity of labor (the labor theories
of value) , opportunity cosr (value in the next best use)
and replacement cost (sacrifice involved for the possessor
if he were deprived of a gcjod cr service and wished to
recover it) . It is easily assumed that some of these con-
cepts are more objective rhan others; we reject this as-
S'omption, and postpone examination of the concept of cost
as a surrogate for value to a later place.

- 2:

Acooiinvi7ig Distinguished from Statistics

It wij.l be seen that accounting is a branch of
numerical analysis applied to economic activity, and some
v;riters have viewed it as a branch of statistics.'' It is
clear that accounting data are available for statistical
uses, and both macro- and micro-economic studies have pro-
ceeded from this observation; business statistics include
accounting data together with other measurem.ents . Scott
looked forward to an i.ntegration of accounting and statis-
tical processes, and postulated as the logical outcome of
this "evolution" a "consistent hierarchy of rules and
principles proceeding from the specific and detai led to
the more and more general until the broadest accounting
principles merged into still broader principles of social
o-rgani^ation. "^ Vvhile it is not disputed that accounting
and statistics are related methodologies, or that both can
find a place within a socio-economic conceptual framework,
it is important here to establish the differences between

them.

In the first place, statistics (as the name implies)
is essentially staric, whereas accounting, as we have shown,
is based on dynamic elements. A static model is one in
which important variables are assumed to be unchanging,
and in this sense all models have static aspects, including
accounts. The kev variable in this context, however.

- 23 -

is tine) whereas statistics abstracts from the effects of
time, accounting expressly includes time by dating all
observations. Again, static models can be made dynamic
by dating procedures, but the basis of the distinction
remains; statistical method does not always include time
as a variable.

Secondly, statistics is "State Arithmetic, a system
of computation by which differences between individuals
are elim.inated by the taking of an average."^ "For the
most part, Statistics is a method of investigation that
is used when other methods are of no avail." ^° Statistical
method is required v;hen wa are faced v/ith a large population
and are forced to assume thar the average (however computed)
is representative of the whole. Gini has complained that
modern statistics displays a growing propensity for
formulae, which he D.ooks upon as a sign of weakness in
statistical p:iethod; he believes that the representative
assumption is too readily m.ade on inadequate evidence con-
cerning the population."^ The characteristic feature which
distinguishes accounting here is that, given a definition
of a value or set of values, it is possible to proceed to
manipulate those values through time without any of the
assumptions of consistency and comparability which are
essential to the operation of the laws of chance, to
correlation and the standard deviation, and to those

- 24

other mathematical models v/hich v;e group under the heading
of "statistics. " ^ ^ Thus, statistics begins where accounting
ends, in that, given assumptions of consistency and com-
parability, statistical method can be applied to accounting
dats- We Tn^v refer to financial ratio anal^^'sis as an
example of this.

Thirdly, and in contrast to statistics, accounting
is holistic. We shall observe in the next chapter that this
has not always been the case, and that early forms of ac-
counting v;ere based on a selection process similar to that
which characterizes statistical method at the present time.
In using statistics, we start from, a hypothesis concerning
the key variables to be studied; in accounting, we devise
a closed system within which all identifiable economic values
can be acconmiodated , no matLer how little they may appear at
first sight to affect the result. This brings us to the
fourth difference; accounting methodology includes models
which prescribe the manner in which observations are to be
made; this is the subject-matter of bookkeeping. The rules
and techniques of bookkeeping cannot be divorced from the
subject of accounting, which may be the reason why they
are so often confused.

The Uses of Accounting

Accounting theory is teleological , and as Schumpeter
has pointed out, teleology may be a proper manner of

- 25

approaching the study of purposive human actions. "The
improper use of teleology consists in exaggerating the
extent to which men act, and shape the institutions under
which they live, according to clearly perceived ends that
they consciously wish to realize in the most rational way."^'

If "it is not possible to draw a theoretical line
between economics and politics in the manner and with the
significance so much stressed by most economists in their
methodological discussions,"-'* then it is perhaps advisable
to adopt an express empirical hypothesis concerning this
point. Vie shall use initially the mental construct of a
policy-maker who is at the same time a planner and an
executor of his plans, and concern ourselves with the con-
ceptual framework of this hypothetical businessiaan. ' "" At
a later stage we shall see v/hat modifications the analysis
must undergo if v-;e introduce a separation betv/een policy-
making and planning, and between planning and execution, as
well as a plurality of decision-makers. This device will
permit us to abstract from, behavioral factors, such as
motives and goals, while retaining the general idea of a
purposive human being (Chambers' "actor"' ^) in the context
of a given socio-political envirorunent. The danger to be
avoided is illicit psychological reasoning from the indi-
vidual to society as a vrhole.'''

- 26 -

We face here a number of philosophical alternatives.
If prediction is meaningless, we have no subject for study.
If prediction can be made deductively , not from experience
but from some general principle, or principles alleged to be
logically certain, as in modern theoretical physics, we
must establish the axioms which will underlie our theorems;
such behavioral axioms must be derived from observation of
man in society. Or, we can make generalizations from
experience which, while they can be valid inferences, are
not made with certainty; in this case, traditional deductive
logic would appear to be inapplicable. Finally, we can
subscribe to an induction-deduction process of reasoning
from the present to the future, such as characterizes what
has become knov;n as "the scientific method." In all cases
a description of the environment m.ust be undertaken, and
it is to this task of distinguishing the historical from
the logical that we now turn.

The fact that accounting has invariably been
associated with societies where business has flourished was
to Hatfield "so obvious that I offend by explanation."^®
He was referring to the latter part of the 19th century,
and to Aiaerica, England and Germany; v/e v/ish to shov; thab
this observation can be extended back through time as far
as history will take us, Scotland in the 18th century,
the Low Countries in the 17th, Florence in the 14th, Genoa

- 27 -

in the 13th, Rome at the birth of Christianity; Greece,
Egypt, Persia, Babylon and elsevjhere in the pre-Christian
era — all of these civilizations v/ere characterized by a
developed structure of trade and industry, and have be-
queathed to us accounting records . ^ ^ "Wherever trade
flourished, the practice of double-entry could be found,
lending colour to the views that trade followed double-
entry, or that double-entry followed trade. "^-^

Again, we can verify the fact that accounting did
not develop or occupy a significant role in ages and places
where trade and industx-y V7ere subordinated to conquest and
military adventure, where the aristocratic ethos took
precedence over the bourgeois, no matter how v;ealthy the
peoples concerned may have been. Spain and Portugal in
their glorious centuries, feudal Europe in its "dark ages,"
the ancient empires of Ghengiz Khan and Attila the Hun, have
left us no legacy of accounts.

Obviously, accounting was a result of the invention

of money, and the origins of both are lost in the nists of

antiquity. Discussing the need for a metallic currency in

pre-capitalist times, Sombart says:

"Nov/, a money economy accustcm.s people to look at the
world in a purely quantitative way. When the habit of
applying money as a canon or rule for ail thd.ngs nas
grown for years and centuries, the natural attitude
of mind which regards the inherent and qualitative
differences in things dies out. Aritnmetical valuations —
weight, mass etc. — come to be taken as a matter of course
in everyday life."^^

- 28 -

We need not accept Sombart's assuraption that the
quantitative and the qualitative are mutually exclusive to
see the point of his observation. There is a well-known
hypothesis that writing began in Sumer before 4000 B.C. as
a symbolic accounting, to keep temple records of goods
received and issued. ^^ It is, therefore, not entirely
fantastic to see the origin of a quantitative approach to
life in a need to keep accounts. VJherein lay the basis of
this need?

The customary answer to this question points to the
stewardship function, a requirement to account for the
stewardship of wealth. A typical view is that of Richard
Brov7n, in his classic work on accounting history: "The
development of social life and especially the formation
of states or sovereignties levying any form of taxacxon
necessitated ... a power of holding count and reckoning.
In this we find the origin of the science of accounting."''^
And later, on the subject of auditing: "Whenever the advance
of civilization brought about the necessity of one m.an being
entrusted to some extent with the property of another the
advisability of some kind of check upon the fidelity of the
former would become apparent. " ^ **

It would be tiresome to trace the recurrence of this
theme, but we may note the recent statement, by a prominent
accounting educator, that accounting today is "investor

29 -

oriented"; he also claims that this orientaticn has
prevailed "throughout most of the history of accounting. " ^ '^
The similar observation of Enthoven has already been men-
tioned.^^ We have rejected this hypothesis, hov7ever, since
several contradictory observations have rendered it unac-
ceptable. In our view, the following alternative hypothesis
accords better with the evidence.

In order to accomplish his objectives, man develops
conceptual frameworks consisting basically of representations
of reality — ^raodels — in a form which permits their, elements
to be manipulated for the purposes of prediction, planning
and controls Should I wish to spend my evening at a
particular cinema, I can identify a set of conceptual
frameworks required: a linguistic structure, a knov/ledge
of certain technical equipment, a monetary system. We may
consider additional quantitative models of this kind: if
I am to arrive at my destination, I must possess a geograph-
ical conception of the area in v/hich both I and the cinem.a
are situated; in short, a inental or physical map, complete
with distances. If I wish to be sure to see the whole
picture, I must also have a system for m.easuring tiiae,
which must be identical with that used by the operator of
the theater. All of these are abstractions.

It is suggested that accounting is a combination
of conceptual frameworks, including those of language,

- 30 -

money, time and arithmetic, used by businessmen in their
relations v^ith each other, for purposes of prediction,
planning and control. If this is correct, then the
stewardship function of accounting can be seen to occupy
a secondary role, in importance and in time, to the role
of accounting in economic development, for example, the
creation of v;ealth or the achievement of such other goals
as may be identified from the behavior of businessmen.

Economists ' Uses of Aaaounting

The 20th century interest of economists in
accounting can be viewed as an aspect of their continuing
effort to "grasp the economic order as a unified whole and
to comprehend all its manifestations in a logically coherent
system.''^' If we accept Myrdal's subsequent argument, that
economic theorists have a concern for the improvemcent of
human welfare, it is not inconsistent to assert that they
are interested, in the first place, in describing and
explaining the v^orld as they see it.

The v;ork of the marginalists in the 19th century
culminated in the general equilibrium, models of Walras and
Pareto, which dem.onstrated again {for the point had already
been made by the Physiocrats) that all econom.ic actions
are interdependent. Influenced by this need for a
holistic view, economists have relied largely upon pries

- 31 -

theory as a conceptual frairiework to contain their
observations in all fields. It is possible to discern,
in the 2Cth century, a renewed interest in accounting as
a complementary aid in grasping the economic order whole.

Macro- sconomics

A striking feature of macro-economic theory in the
second half of the 20th century is the use of accounting
methodology for planning and control at the level of the
state: ". . .a method of obtaining an over-all picture
of economic activity is essential. This is the function
of the national income accounts . . ."^^

The first four chapters of the typical macro-econoaiic
textbook from which this quotation is Laken are devoted to
the accounting framework and its relation to the "super-
structure" of Keynesian economic theory within which it
can be placed. ^^ The general acceptance of this approach
can be traced to the v/ork of several economists (notably,
J. R. N. Stone and J. R. Hicks) who, in the 1940 's, drew
attention to the possibility of presenting in this form
quantitative data for macro-economic studies. At the same
time, a didactic purpose can be discerned:

. . . the chapters on definitions, v/hich formed so
indigestible a portion of the old text-books, hcive been
kindled into life by the work of economic statisticians/
and also by some of the nev/er developments of economic
theory. They have grown into a distinct branch of
economics ^ a branch which is being pursued with very
special success at the present time, and which is.

- 32 -

nevertheless, particularly suited to serve as an
introduction to the science in general. If v/e want
a name for it, it raight be described as Social Account-
ing, for it is nothing else but the accounting of the
whole coiraaunity or nation, just as Private Accounting
is the accounting of the individual firm.^°

The accounting approach to macro-economics is not
an entirely nev; departure, having also been attempted by
the P?iysiocrats in the 18th century; Mattessich has demon-
strated the Tableau Eaonomique as a rudimentary system of
national income accounts."^ Studenski identified 50 national
income estimates for Britain and France down to the end of
the 19th century , ^ ^ and a nurriber of other European countries,
as well as the U.S.A. and Australia, experimented in this
field prior to the 1930 's. Several factors combined to
concentrate achievements in economic dccounting, one of
which is certainly the writings or Irving Fisher, which
will be discussed later. Much theoretical worK v;as done
in the 1920 's, notably in the U.S.S.R., which established
national budgets and centralized accounting control after
the 1917 Revolution. The great increase in the size and
scope of government activity after 190 led the countries
mentioned to collect statistics which had not previously
been available, and the extreme economic fluctuations which
accompanied World War I, the boom of the lS20's and the
Great Depression, focussed attention on the need for data
to support economic forecasting. It is nctev;orthy that,
in reply to criticisms raised by Ku::net3 , a group of

~ 33 -

economists and statisticians who had been involved in the
formulation of the U.S. scheme of national inconie accounting
placed emphasis on the analytical, definitional, pedagogical
and statistical benefits to be derived from collecting this
data in the form of a system of acr-ounts . ^ " The objectives
of prediction, planning and control underlie these technical
considerations; at least V7e can assert with some confidence
that the stewardship concept is not much use in this instance,
since it is impossible to determine v/ho is answerable to
whom for the custody and administration of the national
income .

The use of accounts for planning purposes is not a
new feature of governm>ont ; it is frequently forgotten that
businesses took the practice of budgeting from the public
sector. Accounting" for public fujidis v;as known in the
kingdoms of the Nile and the tem.ples of ancient Greece;
one of the fascinating byways of European history reveals
the English, Norman and Flemish rulers using accounts in
the process of converting their tax systems from a commodity
to a money basis. Public finance theorists have long used
government accounts in their empirical studies; we shall
consider the limitations of this source in Chapter V. We
may also note here that the mainstream of ideas in modern
public finance can be traced to Sweden, whose King operated
a double-entj-y budgeting system on the accrual basis for

- 34 -

the state treasury from 1623 onward-''* Enthoven makes
reference to the fact that Simon Stevin's interest j.n ac-
counts was stimulated by the efforts of the Dutch princes
of the 15th and 16th centuries to improve the techniques of
public administration.'^

Interest in accounting as evidence for a positive
theory of public finance has grown with the availability
of national income accounting miodels ; public finance
theorists are also concerned with the problems of planning
and control: "As the economic functions of government
expand, the technical aspects of finance, of public ac-
counting and of the control of expenditure,, assume a new
importance. " ^ ^ Pryor has re.-rently attempted to formulate
a positive theory of public finance based on empirical
evidence as well as intuitive ideology.^'

Kurihara, in sununarizing bhe economic developments
leading to Keynes' General Theory, provides further clues
for the incipient rediscovery of accounting, although we
do not agree with his reasoning. ^^

Kurihara

1. Industrialization and
urbanization in gener-
al and mass production
in particular.

Our Comments

The growth of capital-intensive
firms and credit institutions
destroyed the nexus between re-
ceipts and income, payments and
expenditure, thus increasing
the need to develop dynamic
models of the economv .

- 35

Kurihara

The increasing public
sectors of the econo-
my and the welling
importance of the role
of government finance
for stability and
welfare.

The growing complex-
ity and multiplicity
of the phenomena af-
fecting modern eco-
nomic life require
more and more over-
all information.

The Great Depression
of the thirties .

Our CoFiments

But the emergence of a large
nonmarket sector argues against
the development of dynamic mod-
els based on neo-classical
price theory.

This argument works against
dependence on intuitive sira-
plifications and places great
emphasis on analytical obser-
vations .

But this and other 'similar ob-
servations draw attention to
the need to incorporate expec-
tations in planning and con-
trol models.

Mi- aro-saoncm i. c s

In spite of the evident interest of early economists
in business practices and accounting data, classical and
neo-classical economists have tended to ignore accounting
methodology. This drew the strictures of Irving Fisher,
and Schum.peter regretted that the consequence has been that
economists have had to discover painfully phenomena they
could easily have observed from business sources. Marshall
was obviously familiar with these sources, so much so that
Hansen referred derogatorily to his work as "cost accounting.
The references to I;!ar shall relate to the calculation of cost;
Erich Schneider sumraarizes this approach by saying; "By
the costs of a particular output we understand the money

■; 3 9

- 36 -

value of the quantities of means of production necessary
for producing and selling this amount of goods . . . (the
problems of valuation which arise belong to the field of
business administration. ""* ° There seems to be no dispute
concerning the relevance of accounting methodology to the
cost aspect of price theory.

More recently, the interest of economists in
accounting at the level of the firm has become marked,
notably as a result of Fisher's seminal work . '* ^ We are
of the opinion that Fisher's knowledge of accounting was
not sufficiently extensive to carry the load which subse-
quent theorists have attempted to make it bear, but there
can be no question of the importance of his contribution
to capital theory, or its influence on eccnomic and
a&counting theories. Indeed, Fisher's definitions and
assumptions have been largely incorporated into present-
day national income accounting,'*^ where they wreak incal-
culable harm.'*" Tlie influence on accounting theory v/as
transmitted through Fisher's pupil. Canning, whose v^7crk is
an attempt to evaluate accounting in the light of Fisher ian
concepts of capital and income.'*'*

Two developments can be identified as flov/ing from
this re.'^^ival of interest in accounting. The first, which
can also be tx'aced to Wicksell,^^ is the attempt to base

- 37 -

economic decisions on accounting models, such as the
"cost/benefit" approach to governnient taxation and pub-
lic expenditure. In Wicksell's terminology, "cost" and
"benefit" bear the same relationship to one another as
"cost" and "revenue" in the profit and loss account of
the firm. In the field of micro-economics, discontent
with the marginal approach to price theory has led some
economists to consider "average cost pricing,." which uses
the profit and loss account model of the firm for explain-
ing price formation; most of the work in this field has
been done by questionnairG, however, rather than on the
basis of account information.

The second of these developments, which is also
not new, is the use of account inform^ation for empirical
work in other branches of economics. A good example is
Krzyzaniak and Musgrave ' s study of corporate income tax
shifting, which applies statistical techniques to account-
ing data.''^ The principal use of accounts in this v/ay
has been in the field of finance, where a considerable
body of v/ork has accumulated in the U. S. and the U. K.
during the past thirty years. "^^

In spite of this, the usefulness of accounts for
economic analysis has been challenged by several critical
economists. We shall discuss Yamey's position in Chapter
III; here we shall rake Eoulding and Flanders as represen-
tative. Eoulding'*^ finds economics and accounting concerned

- 38

with the same subject matter, but sees thorn as occupying
different worlds. Scholars from the one field do not
study the other in any depth, although many economic
questions have been derived from accounting practices,
and some ^ccountinrr rnethods have been develo'^ed to ansv:cr
economic questions. The point of contact, he says, is
the theory of the firm, where the accountant concentrates
on net worth changes, i.e., on the measurement of profit,
or net income. The valuation process v/hich underlies this
computation must necessarily accommodate uiiknown future
events, but the economist regards such a task as an impos-
sible one, so that much of accounting is, to him, ritualis-
tic, providing assurance rather than answers. Boulding
looks to information theory and decision theory as possible
sources from which the integration of accounting and eco-
nomics may proceed.

His pessimism is reflected by Flanders in tv/o
articles which attempt to guide accountancy into the paths
of economics. In the first of these, ''^ Flanders was reply-
ing to a professor of accounting who had suggested that
accountants were wrong to neglect social accounting as a
field of study; he was prepared to place severe restrictions
on the relevance of accounting to economic theory. In the
context of social accounting, a knov7ledge of specific
economic theories was required for understanding the

- 39 -

meaning and uses of a given system of social accounts, and
a knowledge of "general economic theory" to comprehend the
relationships between the different systems of social ac-
counts. The accountant could be no more than bookkeeper?
he "can tell you what accounting methods and techniques to
apply" but "must rely on economics to interpret and explain
the economic significance of the values discovered by the
accounting process." Interdisciplinary studies could
arise through the economist's reliance on accountants in
complex situations v/hich could not even be analyzed with-
out the kind of data accountants produce. The determination
of what economi.c values to quantify was "in the realm of
economic theory . "

Flanders' views echo those of the outstanding
American accounting ^:heori3t, A. C. Littleton, v;ho argued
that the tasks which accountants undertake should be re-
stricted to the area of business money flows, and Flanders
quoted with approval Littleton's identification of account-
ing theory vrith accounting practice. A later article by
Flanders pursues this argument to the conclusion that
accountants should adopt the behavioral, equilibrium, and
restraint relationships used by economic theorists, or
see their functions increasingly filled by operations
research men who will combine accounting data and economic
models.^'' Flanders' logical error is to confuse economics

- 40

with price theory, and to assume that accountants do not

use economic models because they do not use price theory

models, but his belief that economics is ccncerned v/ith

human behavior, and accounting with the given results of

behavior, would find a favorable reception in many quarters,

His assertion that accounting is "mechanistic," and

Boulding's view of it as "ritualistic," raise questions

which must be answered if the theme of this study is to

be accepted.

Some accountants have also challenged ttie validity

of accounting in similar terms. Perhaps the most fluent

statement of this criticism is that of Mattessich, himself

an accountant:

Thus accounting is being criticized for many reasons:
that it is based on irrelevant historical costs instead
of opportunity costs; that it provides only a descrip-
tion of the past, but no prediction of the future; that
its models consist exclusively of identities but lack
behavioral functions and do not lend themselves to opti-
mization procedures; that it ignores psychological fac-
tors and uses "arbitrary" allocation procedures » . .
that the balance sheet is not comprehensive enough
because its inclusion-criterion of measurability is
too superficial; that the additivity assumption on
which it operates is illusionary [sic] ; that its
measures are not accompanied by error estimates, etc . ^ ^

Mattessich refutes these accusations on the grounds

that it would cost more than it would be worth to improve

accounting methodology in the desired direction, but this

is surely the weakest of arguments; if the criticisms are

justified, the cost argument implies that the opportunity

- 41 ~

cost of doing better would be very low indeed. We shall
attempt to show that all these criticisms stem from a
misunderstanding of the basic features of accounting, and
disappear when we accept the idea of accounting as a closed
system which represents certain aspects of the realities
of human intercourse, and when we abandon the unnecessary
assumptions of profit maxim.ization and income (profit)
determination. In short, v;e sympathize with those who
are impatient with the shortcomings of accountants, but
attribute them to human weakness and lack of application,
rather than to inherent deficiencies of accounting theory.

NOTES

1. Gunnar Myrdal, The Potitioal Element in the Development
of Eoonoinio Theory (Harvard, 1955), p. 154.

2. Boullet and Serieys have shov/n that double-entry book-
keeping is simply a special case cf integrated multiple-
entry bookkeeping. See "Les moyens de traitement
^l^ctroniques et 1' Evolution des concepts traditionels
de comptabilite, " Paris, La Revue Francaise de
Comptahilite (February, 1967) , p. 55. Cost account-
ing typically involves triple-entry; national incom.e
accounting, quadruple entry, which becomes sextuple
entry at times.

3. R. Mattessich, Accounting and Analytical Methods

(Homowocd: Richard D. Irv/in, 1964), pp. 26-27.

4. J. R. Hicks, Capital and Growth (New Yorlc and Oxford,
1965) , p. 28.

5. J. A. Schumpeter, History of E-jonomic Analysis (Nev
York: Oxford University Press, 1954), p- 61.

6. Ibid.

7. DR Scott, "The Influence of Statistics upon Accounting
Techniques and Theory," The Accounting Review, Vol. 24

(January, 1949), pp. 81-87.

8. Ibid., pp. 84-35.

9. M. J. Moroney, Facts from Figures (3d ed . ; London:
Penguin Books, 1961) , p. 1.

10 . Jiia. J p. 2 .

11. C. Gini, "On the Characteristics of Italian Statistics,"
Journal of the Royal Statistical Society, Vol. 12S,
Part I (1965) , p, 105.

12. Exam.ples of the use of averages can be found in
accounting, e.g.. the weighted average cost method
of pricing materials issued from a stock.

- 'i^ -

- 43 --

13. Schumpetcr, p. 58, n. 4.

14. Myrdal, p. 11.

15. The method is sirailar to that adopted by Knight ii
his discussions of uncertainty. See Frank H. Knight,
Risk J Uncei-'tainty and Profit (Nev7 York: Harper
Torchbooks, 1955), Chs. XI and XII.

16. R. J. Chambers, Towards a General Theory of Acaounting

(Adelaide, 1961), p. 5, et. seq.

17. Myrdal, p. 13.

18. Henry R. Hatfield, "An Historical Defense of Book-
keep.i.ng," repr. in VI. T. Baxter (ed.) Studies in
Acaounting (London: Sweet and Maxwell, 1950), p, 10.

19. See, for a chronological list of significant dates in
the history of accounting, George Abs. et al . , "His-
torical Dates in Accounting," The Aooounting Review ^
Vol. 29 (July, 1954), pp. 486-93. See also: A. C,
Littleton, Acaounting Evolution to 1900, (Nev; York:
American Institute Publishing Co., 1933); S. Paul
Garner, Evolution of Cost Accounting to 1925 (Alabama,
1954), espec. Chs. 1 and 2? Joseph H. VDaemminck,
Histoires et Doctrines de la Comptabilite , Brussels:
Eds. de Treurenberg (1956); David Murray, Chapters in
the History of Bookkeeping , Accountancy and Commercial
A.vithmetic (Glasgow: Jackson, Vifylie & Co., 1930).

20. B. S. Yamey, "Scientific Bookkeeping and the Rise of
Capitalism;" repr. in Studies in Accounting y op. cit . ,
p. 16 .

21. Werner Sombart, The Quintessence of Capitalism , transl.
M. Epstein (New York: E. P. Dutton & Co., 1915), p. 309

22. William H. McNeill, The Rise of the Vest (Chicago,
1963) , p. 54.

23. K. Brov7n , A History of Accounting and Accountants
(Edinburgh: T. C. and E. C. Jack, 1905), p. 16.

24. Ihid., p. 74.

- 44 -

25. Sidney Davidson, Arthur Young Professor of Accounting
at the University of Chicago, in "Accounting and
Financial Reporting in the Seventies," The Arthur
Young Journal (Spring/Summer, 1969). The view
echoes Knight, pp. 30 3-4.

26. Supra 3 p. 5.

27. Myrdal, p. 28.

28. T. F. Dernburg and D. M. McDougall, Maaro-Eoonomias
(2d ed.; Nev; York: McGraw-Hill, 1963), p. 2.

29. See also Gardner Ackley, Maaroeoonomia Theory (New
York: The Macmillan Co., 1961), Chs . I-IV.

30. J. R. Hicks, The Social Framework (with A. G. Hart)
(New York and Oxford, 1945), p. xii.

31. Op. cit.^ pp. 106-18.

32. Paul Studenski, The Income of uations (New York,
1958).

33. M. Gilbert, G. Jaszi, E. F. Denison and C. F. Schwartz,
"Objectives of National Income Measurement: A Reply

to Professor Kuznets," Revue of Economics and Sta-
tistiacj Vol. 30 (August, 1948), pp. 179-95.

34. Per V. A. Hanner, General Ledger of the Kingdom of
Sweden^ IS 2^ (Stockholm, 1952) .

35. Adolf J. H. Enthoven, "Finance and Development,"
International Monetary Fund^ Vol. 6, No. 2 (June,
1969) , pp. 16-23.

36. Ursula K. Hicks, Public Finance (Cambridge, England,
1955) , Preface^., p. ix.

37. Frederic L. Pryor , Public Expenditures in Communist
and Capitalist Nations (Homewood: Richard D. Irwin,
Inc., 1958),

38. Kenneth K. Kurihara, Introduction to Keynesian
Dvnam.ics (London: Geo. Allen & Unv/in, Ltd., 1964),
p"! 17.

- 45 -

39. Alfred Marshall, Frinaiples of Eaonomias (8th ed.;
New York: The Macmillan Co., 1948), espec. pp. 360,
394 and Book V, Ch. VII, Book VI, Ch. VII; also

p. 406.

40. Pricing and Equilibrium, transl. Esra Bennathan (New
York: The Macmillan Co., 1962), p. 79.

41. Irving Fisher, Tke Nature of Capital and Income (New
York: The Macmillan Co., 1906).

42. Ingvar Ohlsson, On National Accounting (Stockholm:
Konjunkturinstitutet , 1953), p. 48.

43. See infra, Ch. VI.

44. John B. Canning, The Economics of Accountancy (New
York: The Ronald Press Co., 1929).

45. Knut Wicksell, "A New Principle of Just Taxation,"
transl. J. W= Buchanan, in R. A. Musgrave and A. T.
Peacock, eds., Classics in the Theory of Public
Finance (Nev; York: The Macmillan Co., 1958),

pp. 72-118.

46. M. Krzyzaniak and R. A. Musgrave, The Shifting of the
Corporation Iricome Tax (Baltimore, .1963).

47. In the V. S. , see the National Bureau of Economic
Research Series, particularly the compilation on
"Research in the Capital Markets," a supplement to
The Journal of Finance, Vol. XIX (May, 1964), In
the U. K. . see the publications of the National
Institute of Economic and Social Research, Cambridge
University Press, notably Studies in Company Finance ,
eds. Brian Tew and R. F. Henderson (1959) , and Tibor
Barna , Investment and Growth Policies in British
Industrial Firms (1962) .

48. K. E. Bo'-lding, "Fconnmics and Accounting: The
Uncongenial Twins." repr. in Studies in Accounting
Theory, eds. W. T. Baxter and Sidney Davidson

(Komewocd: Richard D. Irwin, Inc., 1962).

49. Dwight P. Flanders, "Accounting and Economics: A
Note with Special Reference to the Teaching of Social
Accounting," The Accounting Review, Vol. 34 (January,
195S) , pp.' 68--73.

- 46 -

50. Dwight P. Flanders, "Accountancy, Systematized Learning
and Economics," The Accounting Review f Vol. 36 (Oc-
tober, 1961), pp. 564-76, espec. p. 576.

51. Mattessich, p. 414.

CBLAPTER III
THE SOMBART PROPOSITIONS REVISITED

We have stated that accounting is in the first place
a conceptual framework useful for planning economic activ-
ities, and that its control function is derived froFi its
planning function. A similar proposition, or set of pro-
positions, was formulated by Sombart, whose erudition in
this field has not been challenged.'^ We shall outline
Sombart 's position, and Yamey ' s criticisms of it, and show
how V7e differ from both Sombart and Yamey in our interpre-
tation of the evidence which they adduce, and on which v/e
also rely in great measure.

The Epstein translation was originally published
in German in 1313, under the title VeT Bour-geois , and the
brief comments on accounting contained in that early work
were subsequently expanded and more fully documented by
Sombart, in a work which does not appear to have received
translation into English.^ Because of the significance of
the relevant passages of the later work for the ideas devel-
oped in this chapter, v7e have prepared a fairly complete
translation of Sombart 's comments on accounting and the
gro'vvth of scientific business management, v/liich v/ill be
found at the end of this study.

- 47 -

- 48 -

Sombavt and the Rise of Capitalii

The Origins of Capitaltsm

Sombart attempts to trace several causal factors

which led eventually to the emergence of a capitalist

civilization. He defines capitalism thus:

By "capitalism" we mean a particular economic system,
recognizable as an organization of trade, consisting
invariably of two collaborating sections of population,
the owners of the means of production, who also manage
them, and propertyless workers, bound to the markets
which they serve; v/hich displays the two dominant prin-
ciples of Vv'ealth creation and economic rationalism. -

The essential features are the profit motive and
rationality; an exchange economy, in which the m^aterial
requirements of several trades are satisfied by free ex-
change? of equivalent goods or money, may be either arti-
sanal or capitalistic.'*

Sombart takes as his point of departure a precapi-
talistic feudal society in early medieval Europe, when a
sufficiency for existence was the goal of everym.an. He
then poses the question: by what means was society trans-
formed into a different one, in which the profit motive
replaced the satisfaction of basic wants as man's main
driving force?

The spirit of enterprise manifests itself in per-
sonalities like the "freebooter," the "speculator" and
the "projector," who rely on robbery of economic surpluses

- 49

created by others to form the capital necessary for their
undertakings. Such ra^n can be found throughout history,
but the qualities of the bourgeois capitalist are not so
common; they include an organizing ability, a facility
for rapid calculation, and the art of planning outl£\ys.^
What turns the craftsmari into a manufacturer? In two
words, he must be able to calculate and to save.^ Sornbart
sees the transition as a function of mental or spiritual
changes which resulted in man ceasing to see himself as
the center of his universe, and replacing himself with the
institutions and material objects of a capitalistic society.
This change in attitudes was dependent upon, if not actually
caused by, the m-ensuration process.

Thought in economic activities, then becomes more
definite and conscious, in other words, more rational,
and modern technical science has tended to make it so.
^ But it has also helped to make it more exact and punc-
tual, by providing the necessary machinery for meas-
uring time.

Clocks have played a very important part in the
mental history of the business man. Pendulum clocks
are said to have been invented in the 10th century,
while the first clock worked by wheels vias that made
by Heinrich von Wick, in Paris in 1364, for King
Charles V. . . . Now, the exact measurement of time
became possible only when the necessary instruments
were available, just as the exact calculations in
terms of money became possible only when technical
progress was able to provide a reliable currency.^

The two elements are combined succinctly in
Benjamin Franklin's dictum: Time is money.

The ability to calculate can create wealth when
combined with the requisite institution: The capitalistic

enterprise. In Der Plodevne Kapitalismus Sombart describes
the special .features of this institution: "... the
complete independence of the business, raising an inde-
pendent economic organization above the individual economic
men involved in it; the combination of all concurrent and
successive business operations into a conceptual entity
which then appears as the performer of the individual
economic actions, and leads a life of its own extending
beyond the lives of the persons concerned."®

Such entities had existed previously, but always
tied to a named group of partners, family, villagers. The
new concept of "the business" effectively separated the
economic relations from the persons; property rights were
depersonalized, permitting "it" to pursue profit without
regard to any other goals.

Three causal factors contributed to the independence
of the capitalistic enterprise:

1. The law "Firma" (the firm)

2. Business management leading "Ratio" (the account)

techniques to

3. The market "Ditta" (credit)

That is to say, the business could be viewed as a
legal entity, an accounting entity and a credit entity. We
are concerned here with the business as accounting entity.

- 51 -

The Business as Accounting Entiby

The invention of accounting was vital to the
development of the capitalistic enterprise. In particular,
double-entry bookkeeping permitted the full representation
of the flow of capital through a business: "... from
the capital account to the transaction accounts through
the profit and loss account and back into the capital ac-
count. "

This facilitated concentration on the idea of
creating wealth; the "wealth producing sum" or anount in-
vested for the purpose of obtaining profits was separated
from all want-satisfaction objectives of the persons in-
volved. In double-entry bookkecpinc there v/as only one
objective: the increase of a sura of money.

The concept of "capital" could only be formulated
under these conditions; prior 1:0 double-entry bookkeeping
there was no "capital"; thus, capital could be defined as
the property of v/ealth represented in a double-entry system.
of accounts . Double-entry bookkeeping also led directly
to the principle of economic rationality- Since the book-
keeper recognized no economic processes outside the books
of account, and nothing could be recorded in these unless
it v/as capable of expression in monetary terms, production
and consumption could be reduced tc calculation.

Economic rationality went hand in hand with

planning and control; the accounting system permiitted the

52 -

analysis of business operations and the establishment of
plans for their progressive and systematic improvement.
In this way did the invention of double-entry bookkeeping-
create the necessary conditions for the essential principles
of capitalism to develop. FurLher, it created tlie concep-
tual framework which was required in order to grasp the
nature of a capitalistic economy, by means of concepts
such as the classification of assets into fixed and circu-
lating, the ascertainment of costs of production, and so
on. The scientific equipment of economic theory, insofar
as it related to captialist economies, was taken from
double-entry bookkeeping.^"

Finally, since the separation of the business from
its owners was a necessary feature of the capitalistic
enterprise, systematic bookkeeping gave material aid to
the creation of the capitalistic enterprise. The business
replaced the entrepreneur; the firm, represented by its
capital, appeared as an accounting entity and the person
of the entrepreneur was clearly shov/n to be a separate
entity, more like a creditor than an owner.

Sombart does not claim to produce evidence that
this theoretical argument can be empirically verified;
indeed, he complains on several occasions of the paucity
of historical materials available to him. He does claim
to be able to see the slow development of double-entry

53 -

bookkeeping taking place side by side V7ith the growth of
juridical concepts of the firm as a separate entity, and
that these changes coincided with what he terms "the period
of early capitalism"'; he also refers to parallel develop-
ments in a number of European countries as evidence of a
tendency. Further, the rise of capitalism took place
unevenly, so that artisanal and other precapitalistic
features can be discerned in the business enterprises of
the period. The organized and systematized business man-
agement which accounting made possible is perhaps an ideal
type, represented by only a fev; outstanding examples, while
the majority of businesses remained .rooted in traditional
inefficiencies; nevertheless, he concludes with conviction
that, starting in Ibaly in z.he 14th century, new principles
of business management were adopted, and their applicc.ticn
depended upon accounting systems based on double-entry
bookkeeping .

Yamsy and the Sombart Propositions

Son\bart's work has been assimilated into the
mainstream of economic history and his view of the nature
and origins of double-entry bookkeeping into accounting
theory.'''^ However, in two papers published at an interval
of fourteen years, Yamey has expressed criticism of what
he calls "the Sombart propositions" relating to the
connection between double-entry bookkeeping and the ris.9
of capitalism.*^

- 54 -

In the first of these papers , Yamey denies that
the management objectives identified by Sombart — clarity
of contractual relationships, economy of expenditures — can
be pursued only through double-entry bookkeeping; he sug-
gests that single-entry will do as well. As to the origins
of the former, while he harbors some confidence in the
asseirtion that double-entry bookkeeping had its origins in
medieval Italy, he says: "But in the nature of things we
are on less sure ground when trying to explain the process
whereby earlier collections of incomplete and unorganized
commercial accounting records become transformed into a
systematized and simple yet elegant arrangement of inter-
locking accounts . "

He puts forward four possible hypotheses, viz.,

1. The single inventor

2. The spirit of the Renaissance

3. The result of chance or accidental influence

4. The necessary outcom.e of a purposive evolution
Yamey is unwilling to subscribe to any of these;

while he is prepared to see some utility in accounts, he
finds that evidence of how they V7ere used is missing. In
his view, "narrow" bookkeeping purposes predominated,, in-
volving comprehensive and orderly records of past trans-
actions, and checks on accuracy and completeness. Financial
statements of profit and loss or of capital, assets and
liabilities were relatively unimportant.

- DD

In the second paper Yamey addresses himself again
to the refutation of the SoK'ibart propositions that book-
keeping aided the rise of capitalism and that double-entry
bookkeeping made possible the separation of the business
fx'Om its ov/ners. Ke eAaxuines " . ., , the simple question
provoked by the thesis, namely, the contribution of double-
entry accounting to the solution of problems in business
organization and adm.inistration . " He would shov; that the
contribution v/as small, and "not made by those features
of the system or in solving those business problems par-
ticularly emphasized by Sombart ... I also suggest,
incidentally, that in the context of the solution of
business problems, double-entry bookkeeping v;as not greatly
superior to less elaborate methods of accounting."

Yamey expresses the strange viev; (strange, that is,
for an economist) that abstraction may lead to less suc-
cessful decision- making, since the decision-maker "...
would have had to view the complexities and detail of
reality through the drastically simplifying and possibly
distorting screen of his accounts." He finds little or
no evidence that accounts were used in the decision proc-
esses of 17th and 18th century entrepreneurs whose books
of account he has examined, and, indeed, would be surprised
to find any, since "steps in the dark" ].ie at the heart of

- 56

capitalistic entrepreneur ship. "Thus, when the businessman
expresses himself most emphatically as entrepreneur he is
necessarily without benefit of accounting records pertaining
to past events and experiences." "Insofar as the early
centuries of capitalism can be described as a period of
dynamic change from a static base— —itself a dangerous sim-
plification — -one would have to discount heavily the con-
tribution made by systematic accounting or accounting
calculation. "

He also draws upon the evidence provided by the
accounts of partnerships and joint stock companies to show
that the business could be, and was, treated as distinct
from its proprietors even in the absence of a double-entry
bookkeeping system complete v/ith capital and profit and loss
accounts.

Yamey commences his paper with the statement that
"Sombart's work gave prominence and prestige to the humble
art of accounting by ascribing to it wide economic signif-
icance." He concludes that "In the achievement of other
aspects of successful enterprise . . . accounting records
and accounting systems have only a humble, but nevertheless
interesting, contribution to make."

In taking a position on these arg\im.ents we shall
concentrate on the later paper. It will be apparent from
Chapter II that we agree generally with Yam.ey ' s criticism

- 57 -

of the Sombart propositions , particularly insofar as we
see no special significance in double-entry bookkeeping
other than that it permits accounting functions to be
performed efficiently.

It is undoubtedly true that the mechanics of
double-entry bookkeeping cannot be observed before the
14th century, but we may remark that, when observed, the
system is so v'ell formed that it is unlikely to have been
a new invention. The accounts of Pope Nicholas for the
year 1279-80 and the expenditure book of Florence for the
year 1303 are fairly complex examples of simple bookkeeping,
but the books of the City of Genoa for 1340 display a
double-entry structure v/hich ruast hav3 been long in the
making. In this respect we tend to agree wj. ch Sombart
that the m.ethod must have been "... well establ^.shed
for a long time."^^

Nevertheless, Yamey ' s claim that single-entry
will do as m.uch reveals that he has overlooked Sombart 's
remark, admittedly expressed in a bibliographical note,
that Pacioli's double-entry did not grow out of single-
entry bookkeeping, the latter being a "crippled" version
of the former, and of later date . ^ "* Business accounts of
the early Middle Ages were quite different in form.; Sombart ,
calls them "sparse and confused" collections of notes.

- 58 -

This point acquires some significance in relation to the

arguments of the second paper.

They begin with this statement:

knov/ledge of the total profit of an enterprise for a
period, either absolutely or in relation to the amount
of capital in the enterprj.se, is rarely necessary or
useful for business decision-making within that enter-
prise. In a continuing enterprise, knov/ledge of the
total or aggregated profitability or rate of return on
capital is not relevant to current decisions which
are concerned with changes in the use of part of the
resources at the firm's disposal, and these, in turn,
are related to the expected profitability of the various
separable activities constituting the firm's total
activity and of other activities under consideration.^"

There is obviously a valuation problem here; if the
immediate past use of capital is a continuing alternative,
the past rate of return constitutes the opportunity cost
of capital and is a necessary element of a decision model.
Generally speaking, one cannot change direction rationally
without knovring where one happens to be, and the relevance
for the future of the profit of past periods is a question
of fact in each case. Perhaps the view of the entrepreneur
as Janus is obscured by a tendency to read "year" for
"period," a natural result of the preoccupation v^ith
financial journalism to which v/e have drawn attention; a
declining trend of weekly profits v;ould certainly not be
irrelevant to a baker cr brewer.

We must agree v;ith Yamey's statement (p. 120) that
calculations of profit or of total capital can be made

- ^Q -

independently of a system of double-entry bookkeeping, since
"profit" and "capital" may be defined in such a. way that it
must be true. The proprietor of a "small business" (such as
Marshall's locksmith employing thirty hands, or a motel with
twenty rooms) may be able to accum.ulate data under his hat,
but the emergence of a hierarchical structure in a business
automatically separates the entrepreneur from the source of
his data, and renders formal record-keeping obligatory.
Double-entry bookkeeping, in our view, is simply an effi-
cient and widely-accepted method of doing this, in both sim-
ple and complex business situations.

We must also consider the possibility that the
single-entry bookkeeping systems referred to by Yam.ey v^ere
in fact truncated double-entry systems like the one popular-
ized in the 18th century by the indefatigable Jones of
Bristol. The use of aggregates is common to both single-
and double-entry bookkeeping, and it. is not essential in
the latter system for each individual entry to be made twice,
once on each side of an account. The basic equation of
double-entry bookkeeping

Assets = Liabilities + Proprietors' Capital
leaves to the individual accountant the task of determining
how these aggregates are to be derived; the number of pos-
sible solutions to this problem is infinite. As long as a

- 60 -

balance sheet and profit and loss account dovetail into one
another through the profit (or loss) figure, the equation
can be established. It is fairly coimicn to find double-
entry accounts which have not been formally completed by
writing up a balance sheet and profit and loss account in
the ledger, although the continental European tradition
would see such a deficiency as more grave than it appears
in the U. S. A. or in Britain. In such systems, these ac-
counts can be seen as loose-leaf parts and are no different
in kind from the loose-leaf sales account (composed of cop-
ies of the sales invoices) or the somev;hat bizarre bits and
pieces of an electronic data processing accounting routine.
Yamey himself refers to the possibility that these incom-
plete, or single-entry, systems were completed in an infor-
mal manner, one less likely to leave traces than the bound
books w^hich contained the transaction accounts.

Further, Yamey admits that ". . .it is generally
impossible to deduce from the records (or textbook discus-
sions) precisely what was intended or achieved by the pro-
cedures in question." ^° We may therefore conclxide that the
way is still open to the acceptance of the Sombart hypoth-
esis, that double-entry bookkeeping assisted the rise of
capitalism by providing the capitalist with a pov/erful
instrument for the management of a business.'^

- 61

The assertion that double-entry bookkeeping was not
a necessary condition for the separation of finance from
production, which occurred during this period of early cap-
italisra, is also debatable. It will be appreciated that
the only accounts affected by the ownership of a firm are
those relating to capital and profit. The only way in which
accounting could have aided the creation of independent
enterprises, therefore, is by techniques of accounting for
capital and profit. If such accounts were not made up, as
Yamey suggests, then his assertion is obviously true. Again,
where the enterprise was not separate from its proprietor,
as in the cases he mentions , these accounts would not have
been called upon to perform any special function.

Early form.s of corporate enterprise were of a
temporary or "joint venture" kind. Trading operations,
consisting very often of voyages by land or on sea, were
treated as separate cycles, and on their conclusion the as-
sets of the venture were divided among the participants in
proportion to their investments. The dividend liquidated
the firm>. Maintenance of capital and m.easurement of profit
were of little significance to plural owners of this kind,
although highly important to owners of banks and factories,
as the accounts of the Medici, Datini. Fuggers and others
demonstrate clearly.

With the growth of continuing businesses, however,
such as the chartered companies in Britain, the problem of

- 62 -

separate personae of owners and managers manifested itself.
The maintenance of the firm's capital could no longer be
the direct responsibility of the individual proprietor, and
he came to rely more and more upon a balance sheet presen-
tation to satisfy him on the condition of his investment.
More important than this, however, and resulting from the
fact of a changing body of shareholders, the profit and loss
account begins to take on a different function from the one
mentioned by Yamey, of reviewing overall business results
(p. 119) . It becomes necessary to ascertain "a" profit
figure in order to treat equitably successive groups of
shareholders. The profit of the firm is a jointly owned
residue and must be apportioned between periods, a feature
which underlies all problems of profit measuren'.ent.

The point Yamey makes is that some 17th and 18th
century companies whose records have survived did not keep
capital and profit and loss accounts, and therefore that
these accounts cannot have been necessary for the separation
of the business from its owners. We find the evidence in-
conclusive- for reasons already given; on the other hand,
we cannot envisage the continuance of such a separation for
any length of time without a necessity to render account
making itself felt. The spectacle of a succession of Brit-*
ish companies acts in the 19th century, each of which placed
great importance on financial reporting and auditing, and

- 63 -

the fact that this was done in order to protect financial
investors in companies, is highly suggestive, to say the
least.

It is only fair to point out that in his
"Introduction" to Studies in the Histopy of Accounting'^ ^
Yamey took some pains to emphasize that he was concerned
only with criticizing the tendency to exaggerate the econom-
ic significance of double-entry bookkeeping, rather than
accounting generally.

The Sombart Hypothesis brought Up-to-date

Sombart 's Assumptions Criticized

Although we have failed to find much substance in
Yamey 's detaj.led criticisms of "the SomJoart propositions/'
we do not accept Sombart 's views as they stand, and soms
distance separates our thesis from his. It will be found,
however, that this separation does not lead to conclusions
which are diametrically opposed.

Sombart was undistinguished as a forecaster.
Writing shortly before World War I he predicted an end to
large-scale wars, a declining world population and the im-
pending disappearance of capitalism. Besides a defective
telescopic vision, however, he also displayed attenuated
historical perspective, attributable in some measure to the
paucitv of source material then at his disDosal. Another

- €4

reason for his failure V7as methodological; in the preface to
the second edition of his work on the rise of capitalisra, he
confessed to a tendency not always to distinguish clearly
between the empirical and the theoretical, a trait which had
been brought to his attention, in the friendliest manner, by
Max Weber.

On the other hand, we cannot ignore his great
contribution to the subject which is the field covered by
this study. In the first place, Sombart was one of the
first modern socio-economic theorists, attempting to vzeave
together threads from several disciplines in order to create
his tapestry of the origins of modern capitalism. Secondly,
and with one exception which will be noted later, he care-
fully examined all the source materia.ls th-^n available to
him, and did not hesitate ro draw conclusions from cliem even
if these contradicted the conventional wisdovi of his time.
Thirdly, the manner in which he integrated his knov/ledge of
accounting into his socio-economic framework is far more
sophisticated than any other attempt which has been made to
combine accounting with economics for purposes of evaluation,
and eventually, prediction. One can only speculate on the
progress of social accounting if Fisher, Hicks or Stone had
possessed a comparable grasp of accounting theory. Finally,
as we have mentioned several times, his propositions lie

65 -

close to the central postulate of the present study and have
probably contributed to its formulation.

It is significant, however, that Sombart made no
mention of Niebuhr ' s claim to have discovered, in the Vati-
can fragments of the oration Pro Fonteic , evidence that the
Roman quaestor-s used double-entry bookkeeping, invention of
which could not, therefore, be attributed to the Lombards. ■^^
This claim has been denied by other historians^" but refu-
tation had not been made when Sombart wrote ; en the other
hand, it is hard to believe that he, with his great erudition,
was unaware of the contents of Kiebuhr ' s German language
masterpiece, particularly since it was over one hundred years
old at the tim.e he wrote Lev Modcrne Kapitalismiis . The evi-
dence v.Tould , of course, have been fatal to his thesis that
double-entry bookkeeping was a creation of the pericd of
early capitalism, although it might net iiave destroyed the
validity of his v;ider propositions. Interestingly enough,
de Ste. Croix in his lengthy treatise arguing against the
view that double-entry bookkeeping v;as known to the Greeks
or Romans, makes only one brief reference to Fro Fonteio , in
another connection altogether.

How, then, do we differ from Sombart? Like him we
have chosen a tribological" ^ approach to cur subject matter,
but during the intervening sixty years his appeals for

66 -

additional historical materials have been answered in large
measure. Not only have accounting historians such as Melis,
de Roover, Yamey and Moininen contributed to our knowledge of
this field, but also archaeologists (Woolley) , antiquaries
(de Ste. Croix, Elizabeth Grier) , students of the adminis-
tration of medieval manors (Hudson) and of Roman Law
(Jolowicz, de Zulueta) . We may also refer here to
Schum^jeter ' s important contribution of a theory of economic
development ^^ and to the many investigators of the history
of scientific thought, who have taught us to be x>7ary of the
very idea of "invention," As a result of tbese researchers'
efforts we can no longer see the rise of capitalism in the
same historical light.

Mandeville, in his Fabls of the Btjea^ oy Privc.te
VlasSj Pukliak Bene fits j pointed out that the prosperity of
a nation depends upon the acquisitive efforts of its citi-
zens, and ultimately on such immoral qualities as ambition
and a desire for power and luxury. The social problem is,
and always has been, to reconcile this with justice, chari.ty
and equality. The Roman triumvirate of Pompey, Crassus and
Caesar, taking for themselves the spoils of the Mirhridatic
War, may be classed as speculators, or even as robbers, but
the Roman colonists who settled Africa were as strongly mo-
tivated to create wealth and by economic rationality as any

- 67

late medieval capitalist. The history of Carthage shows
that, prior to its destruction, large-scale manufacture of
furniture, beds, mattresses and pillows was undertaken for
the Roman market, and problems of organization and manage-
ment no doubt arose. Although we can never be certain, from
the evidence now available to us it would appear that the
capitalist-entrepreneur has been known at all periods of
human history. Those socio-economic studies (Huberman's
Man's Worldly Goods is another example) which start with the
concept of a medieval precapitalistic society, ignore the
fact that there v/ere earlier periods v/hen a "sufficiency^ for
existence" v;as not the goal of everyman, ages when the domi-
nant sectors of society pursued the aim of increased wealth
through production and distribution by m.eans of trade,
rather than through robbery and speculation.

Nor can we accept Sombart's psychological assumption
that man occupied the central place in human thought in pre-
capitalist times, but was ousted by institutions and m.ate-
rial things in the period of early capitalism. It was in
this latter period, after all, that Pope wrote: "An honest
man's the noblest work of God"^^ and echoed Charron's dictum:
"The proper Science and Subject for Man's Contemplation is
Man himself."^'* Although Maine's view of history as a move-*
ment from status to contract no longer seem.s irreversible.

68 -

the statement still rings true of the period under
consideration, and it was not until the 20th century that
Sweeney replaced Samson agonistes .

The humanitarian social initiatives of the 19th
century would have been unthinkable in the 11th or 12th,
but we are not on that account entitled to conclude that
people then were somehow different, emotionally or psycho-
logically. We must assume from the great mass of historical
evidence that, in respect of all relevant characteristics,
human beings have not changed during the past thousand years,

The spirit of ursdertaking , Sorabart points out,
combines the qualities of the conqueror, the organizer and
the trader: "... he must by peaceful means influence
masses of people v/hom he does not know so to shape their
conduct that he will derive benefits from it."^^ Sombart
connects the freebooter with the birth of capitalism, but
the freebooter was primarily a species of robber, not. one
who operates by peaceful m.eans. Consider also Sombart 's
view of speculation as the noncalculatory approach to busi-
ness, the attempt to participate in an "inherent and qua.li-
tative" manner in processes which are essentially quantita-
tive and rational.^" We rather see speculation at one
extreme in the spectrum of calculatory activities, lying
imn\ediately beside games of chance, which are easily
accommodated in the calculus of probabilities.

He quotes v/ith approval Heine's words in English
Fragments (1828) , Chapter iv: "Were it possible for the
Irish by a sudden aoup de main to attain to the enjoyment of
wealth they would seize upon it with alacrity. But ask them
to get rich slowly by cultivating double-entry, sitting over
miserable accounts until they are round-shouldered, and they
cannot do it." Wlien the time came for the Irish to choose,
they in fact chose the Sweepstake, an activity almost en-
tirely carried out by "sitting over miserable accounts."

Finally, we reject Sombart's assun'iption that the
concept of capital resulted solely fj'cm the abstraction of a
process of wealth creation (profit) , since it is clear that
"capital" was ascertainable separately from market trans-
actions involving the purchase cr sale of a business, or a
share in one. As we have already attempted to make clear,
this rationalization of Sombart's hangs together with his
assumption that systematic accounting and double-entry book-
keeping are the same, and we do not subscribe to this view-
point.
An Mtsvnati-oe Hypothesis

We shall pose two historical questions:

1. How does a Lebanese money-changer become an
international banker, or an lovra farm boy con-
struct an enterprise big enough to put the world
on wheels?

2. Why are occurences of this phenomenon increasingly
apparent in Europe, starting with Italy in the

- 70

14th century and culminating in the great
entrepreneurial explosion of the 20th century?

Only by keeping these two questions separate are we
likely to throw light on the subject of our debate.

In Sombart's view, "projectors" such as Tonti ,
Caratto and Cagliostro turn into "promoters" of the order
of a Law, de Lesseps, Rockefeller or Mond , through the in-
vention of a conceptual framework which permits them to dis-
criminate between ideas for wealth of the order of fantasies,
and profitable plans which are capable of execution. This
conceptual framework is a combination of double-entry book-
keeping and commercial arithmetic. we subscribe to a similar
hypothesis except that we attribute its origins to m.ultiple
causes and a much earlier period in time; we do not regard
the assumption that the plans must be profitable to be a
necessary one; and we view accounting as a self-contained
conceptual fram.ework different from., although clearly re-
lated to^ the models of commercial arithmetic.

We assume that the human mind seeks certainty and
creates rationalizations in order to displace the unbearable
idea of a purely stochastic environment.^' All conceptual
frameworks are designed to this end; prediction, planning and
control are the essence cf rationalism and by their means v;e
liberate ourselves from the tyranny of birth, copulation and
death. This desire for a certainty of the mind is often

- 71 -

aggravated by religious, political and social upheavals, so
that the individual, robbed of one haven, seeks refuge in
another. Son\bart relates the observation that the U. S. A.
represents the apogee of economic rationality to the up-
rooting of its iirimigrants , and the strangeness of their
environment .

We would replace the Sombartian hypothesis of profit
motivation with the Keynesian view that: ". . . it is prob-
able that the actual average results of investments , even
during periods of progress and prosperity, have disappointed
the hopes which prompted them. ... If human nature felt no
temptation to take a chance, no satisfaction (profit apart)
in constructing a factory, a railway, 5 mine or a farm, there
might not be much investment merely as a result of cold cal-
culation. "^ '

The desire to create a capitalistic enterprise
arises out of a desire to bring goods and services to those
who do not now enjoy them, and the basic problem faced by
the entrepreneur is hov; to finance his enterprise, that is,
how to acquire capital in order to bridge the time gap be-
tween investment, or the allocation of scarce resources for
production, and realization, or the receipt of payment in
some forra from the market to be served. The creation of
wealth and the recognition of profit are separate phenomena.

altViough related; Bohm-Bawerk first pointed out that lapse
of time in the production process was one of the factors
perraitting profit to arise, and Knight confirmed this obser-
vation: "Profit arises out of the inherent, absolute unpre-

r) 1 r'-f-pi V-v 1 1 T -I . r f-\f- ■)- V« -i' r-, /~r ^ ^n +- ^ -P 4-U „ ^^ „ V — T J- ^ j: - .. I i 1, _ i

the results of human activity cannot be anticipated and then
only in so far as even a probability calculation in regai-d
to them is impossible and meaningless."^^

If the entrepreneur does not face this critical
financing problem, he may select whatever conceptual frame-
work seems to him appropriate; not having any necessity to
communicate his plaiis to others he may formulate them in
any way he chooses. Business history is full of examples
of achievers ^^7ho failed at the moment when it was necessary
for them to exteriorize their systems. The historical nov-
elist, Zoe Oldenburg, describes a feudal lord planning to
build a road through his estate, presumably to bring its
economic surplus to a market; he would not have needed ac-
counts to convince a banker of the soundness of his project.

It seems to us, as indeed to Sombart, that the use
of m.athematics in the scientific preparation of decisions
is a quite separate phenomenon fx"om the development of a
conceptual framework which wi].l enable financial plans to
be comitiunicated to financiers and others. The techniques
of "commercial arithmetic" were all known to, and used by,

- 73

the Romans, and to even earlier civilisations. The use of
accounts for planning and control is likewise of great an-
tiquity, but accounting is not built out of compound in-
terest, ratios and percentages. That the two subjects were
treated together by Luca Pacioli and others may have led to
soiTie confusion on this question.

It is suggested here that accounting was not the
product of "the period of early capitalism" but was, in
fact, introduced into the public sector much earlier in time,
for planning and control purposes. The customs of the an-
cient Greek temples and Roman patricians are perhaps open
to historical misinterpretation, but not so the practices
of the Norman curiae in the 11th and 12-'-h centuries or of
the medieval manors of the sanie period. Lyon and '7e^,rhulst
have described in detail how accounts were used by the
Flemish, Norman and French royal courts in the task of mo-
bilizing the countries of Northwest Europe and converting
them from a subsistence to a money economy.'" The records
of the monastic mianor of Norwich in England have informed
us about the use of accounts in the management of the m.e-
dieval religious manors.'^

It is easy to understand, therefore, why, although
double-entry bookkeeping is not observable before the be-
ginning of the 14th century, v/hen observed it displays the

- 74 -

principal featurec recognizable in modern accounting
practice. Music is another example of a conceptual frame-
work which took several hundred years to develop, from a
simple octave recorded by an 8th century monk to the

important for our thesis, hovzever, to see that the slow proc-
ess of constructing complex systems of interlocking accounts
began long before "the period of early capitalism," and is
attributable to economic growth situations of many different
kinds.

The march of events as we see it can be shortly
stated: the decline of the Roman Empire v;as followed by
several centuries of anarchy, from V7hich Europe emerged only
when feudal systems established a measure of political sta-
bility. This political stability permitted the exploitation
of economic surpluses , v/hich the Normans and others sought
to mobilize, and it is perhaps not without significance here
that the revival of commerce and industry which preceded and
accompanied the Renaissance was restricted to those lands
which had once known the benefits of Roman administration.
The Roman trading laws and customs appear to have been re-
vived, for example, in the Jugements on Botes d' Oteron ,
which are one of the principal sources of mercantile law,
and these included the use of accounts, which were first

- 75 -

applied to public administration and then taken up by
private bankers, raanuf acturers and merchants.

Unlike Somibart, who attributes the primitive
business records of the early Middle Ages to man's preoccu-
pation with value in use rather than value in exchange, ^^
we simply see in this evidence of the lack of educational
facilities at that time, and point to other, earlier, pe-
riods when exact calculation and meticulous record-keeping
were fairly common.. As educational facilities expanded,
through the efforts of the investment-minded rulers of the
time, so the number of persons able to use accounts in-
creased, and with then.i, the nuiTionr of potential entrepre-
neurs. Combining this with a money econom.y, the important
technical innovations of the tiiPe (arabic numerals; tne
clock; the printing press; the gun) and capital, however
acquired, we arrive at a picture oi conditions which were
extremely favorable for the growth of capitalistic enter-
prises, to an extent previously unknovm in human history.
Aaaounting , Plann-iy.g and Control

The idea of accounting as a conceptual framework is
clearly brought out in this statem.ent by a German business-
man :

The object of the businessman's work, of his worries,
his pride and his aspirations, is just his undertaking,
be it a com_mercial company, factory, bank, shipping
concern, theatre or railv/ay. The undertaking seems

76 -

to take on form and substance, and to be ever with him,
having, as it were, by virtue of his bookkeeping, his
organization and his branches, an independent economic
existence. ^ ^

Clearly, Rathenau could not have believed that his

business v/as a real entity; he was describing a system which

he had constructed. The use of accounts for this purpose

is also hinted at in the following confession, from

Rockefeller's Memoirs z

From my earliest childhood I had a little book in which
I entered what I got and what I spent. I called it my
account book, and have preserved it to this day.^"*

The modern entrepreneur may phrase it differently,

but the idea has not changed:

What, then, do we chief executives expect nov;adays
from our information systems? First, continual and
sensitive checks on our present progress. We need to
know at once v/hen we are off target. We need to iden-
tify where v/e have gone astray, so that we can take the
necessary action quickly. . . . Isolating the relevant
information and pruning away the irrelevant is an all-
important accountancy function .

Second, we look for a really professional financial
evaluation of the alternatives facing us in the major
policy decisions we have to take. Decisions on such
matters as capital expenditure projects, pricing policy
and so on. ^ ^

Or this forthright statement:

You m.ay take deferred cash flow, or any other method
of comparing a business, but if those figures do not
balance with the annual statement of accounts they are,
in my view, folly and extremely dangerous. ... I
personally never use any figures that do not balance
with the annual statement of accounts . . . . ^ ^

The separation between accounting and mathematics

is very marked in these quotations.

- 77

When interpreting statements of businessmen, it is
important to remember that they are primarily engaged in
creating values, not in transacting. As Knight pointed out,
productive arrangements are made on the basis of antici-
pations, and in an uncertain world these anticipations may
vary from subsequently experienced reality.^' The essential
fact is that men are acting and competing on the basis of
what they think of the future:

The whole calculation is in the future; past and even
present conditions operate only as grounds of pre-
diction as to what may be anticipated.^^

Decision involves comparing a subjective judgment
of the significance of a commodity to the decision-maker
with an estimated future price, and it is in the elaboration
of the subjective evaluation that accounting serves the
planning function. Its use as a control mechanism follows
from its planning function, since we define control as the
systematic measurement of performance against predetermined
standards, with the objects of evaluation and prediction
linking it up again with planning.

The context within which this process takes place
has been described by Mey, using the Limpergean formulation
characteristic of the Amsterdam school of business eco-
nomics.'® We assume a flow of values — Quesnay's pvoduit
sooial seen in terms of Schumpeter's Kveistauf — which starts

- 78 -

from gifts of nature and ends with final consumption. This
flow requires the intervention of business firms ,^ or pro-
ducing entities, which are organized into branches, trades,
industries and sectors; in the last we include organs of
national and local government, without the cooperation of
which production could not take place. These subdivisions
are connected by markets.

The entrepreneur contemplating participation in
this process by contributing a product or service to a mar-
ket must distinguish between the functions of:

1. The acquisition of means of production, resulting
from investment.

2. The human tasks of utilizing these means of
production.

3. The marketing of the product, or its distribution.
Each of these functions has financial implications,

and v;here means of payment are involved in both acquisition
and distribution, money measures can be imputed to invest-
ment and the work involved in production. The entrepreneur
elaborates his business decisions using data derived from
such an imputation, and represents them to himself and to
his financiers in the form of accounts and financial state-
ments. This is the planning function. Subsequently, he
collects data, or measures performance, in the sam^e way,
and it is this control operation which we recognize as
accounting. The planning operation, cr "accounting for the
future," is not different in kind. Our argument is that

- 79 -

the control function of accounting presupposes a prior
planning function, vrhich is implicit in all accounting
systems but only made explicit, in the form of business
budgets, in a minority of cases.

We shall consider in Chapter IV the different models
of this imputation process which have been used by accounting
theorists .

NOTES

1. Werner Sombart, Der Bourgeois (Munich and Leipzig:
Duncker & Hurablot, 1913) , transl. by M. Epstein as
The Quint esccr.ae of Capitalierr. (Mew York: E. P.
Button & Co. , 1915) .

2. Werner Sombart,- Der Moderne Kapitalismus (3d ed.;
Munich and Leipzig: Duncker & Huniblot, 1919).

3. Ihid.^ (Vol. I, 1, p. 319 (our transl.).

4. Ibid., pp. 92-3.

5. Sombart, Quintessence, p. 102.

6. Ibid., pp. 201-2.

7. Ibid. , p. 326.

8. Vol. II, 1, Chapter X, p. 101 (our transl.).

9. The follov/ing is a summary of the contents of the
Appendix.

10. Echoing Proud 'hon: "La comptabilite est toute
I'economie politique et le comptable le veritable
economiste a qui une coterie de faux litterateurs
a vole son nom."

11. See W. W. Cooper, "Social Accounting: An Invitation
to the Accounting Profession," The Aooouyiting Review,
Vol. 24 (July, 1949), p. 233.

12. B. S. Yamey, "Scientific Bookkeeping and the Rise of
Capitalism," Economic Histoi'ij Review, second series,
Vol. I (1949), pp. 99-113, repr. W. T. Baxter, ed..
Studies in Accounting (London, 1950), pp. 13-30; and
"Accounting and the Rise of Capitalism: Further Notes
on a Theme by Sombart," Journal of Accounti?ig Research,
Vol. 2, No. 2 (1963), pp. 117-36.'

13. Quintessence , p. 128.

14. Der Moderne Kapitalismus , II, 1, p. 115.

- 80

- 81

15. Yamey, "Furthar Notes," etc., p. 119.

16. Ibid. J p. 126, n. 17.

17. Quoting Sombart, and also H. M. Robertson, Aspects of
the Rise of Eoonomic Individualism (Carabridge, England,
1933) (which appears to be a bowdlerized version of
Sombart). Yarney ' s n. 25, p. 128 appears to confuse
Sombart 's planning hypothesis with the conceptually
distinct hypothesis that accounting assisted business-
men to prepare decisions scientifically. See Der

■ Moderne Kapitalismus , Vol. II, 1, p. 121.

18. Ed. A. C. Littleton and B. S. Yamey (Homewood:
Richard D. Irwin, Inc., 1956), pp. 1-13.

19. B. G. Niebubr, ffoemise^e Gesohiohte (2d ed.,- Berlin,
1830), Vol. II, p. 673, n. 1319. This note is omitted
from the English translation (London, 1844) .

20. The principal reference is G. E. M. de Ste. Croix,
"Greek and Roman Accounting," in Studies irt. the
History of Acaounting , pp. l'?-74.

21. Tribology = the technology of interacting surfaces.
The term "interface" in cybernetics has a related
meaning.

22. J. A. Schum.peter, The Theory of Eaonornio Beveto-pment

(Nev; York: Oxford University Press, 1961) (first
German ed. 1911) .

23. A. Pope, Essay on Man, Ep . IV, 1. 248.

24. P. Charron, Gf Wisdom, Bk. I, Ch. I (1601), Stanhope's
translation. See Pope, Essay on Man, Ep. I. 1. 57.

25. Quintessence J pp. 52-4.

26 . Ibid. J p. 312 .

27. For a similar statement, see Schumpeter, Theory of
Economic Development , p. 85.

J. M. Keynes^ The General Theory of Employment,
Interest and. Money (New York: Harcourt, Brace &
World, Inc., 1965), p. 150 (first pub. 1336).

- S2 -

29. Frank H. Knight, Risk, Unoevtainty and Profit (Nev7
York: Harper Torchbooks, 1955), p. 311.

30. Bryce Lyon and A. E. Verhulst, Mediaeval Finance

(Brown University Press, 1967).

31. Kenneth S. Most, "New Light on Mediaeval Manorial
Accounts," London, The Accountant, Vol. 160, No. 4910

(January 25", 1969), pp. 119-21.

32. Quintessence , p. 18.

33. Ibid. , p. 173.

34. Ibid., p. 237.

35. Sir Kenneth Keith, U. K. investment banker, reported
in The Accountant, Vol. 161, No. 4952 (November 15,
1969) , pp. 642-3.

36. A. Chester Beattie, Chairman, Selection Trust, Ltd.,
reported in The Accountant, Vol. 158, No. 4S74

(May 18, 1968) , p. 668.

37. Frank H. Knight, p. 272.

38. Ibid., p. 273-4.

39. Abram Mey, "Le circuit economique et sa relation avec
la theorie de la valeur et du calcul rationnel de
I'economie industrielle, " Paris, Revue de I'Economie
Politique, Eds. Sirey (1960), espec. pp. 8 and 12.

CHAPTER IV
THE FOUNDATIONS OF ACCOUNTING THEORY

In putting forward the proposition that accounting
antedates the rise of modern capitalism, and that its ob-
jective was primarily to aid planning and control rather
than the stewardship of v^ealth, we place ourselves in direct
opposition to some notable historians of accounting.
Littleton argues that accounting is a recent invention,
and although Garner disagrees with him in this, he never-
theless sees cost accounting as a 19th century phenomenon.^
It is, of course f difficult to avoid the temptation to mis-
read records of the past, and the modern micanings of the
words "account" and "accounting" may well be fundamentally
different from the meanings of similar words used by Zenon
and Cicero. On the other hand, we have suggested that tha
views of accounting theorists have been formed as a result
of a technical preoccupation with the features of double-
entry bookkeeping, and we shall now exeimine rhe thesis that
a more fundamental obstacle in the path of understanding is
the fixation with techniques of imputation characteristic
of accounting literature of the last hundred years. This
would explain the fact that Garner's conclusion is so
patently at odds with the cumulative effect of the historical

- 84 -

evidence adduced by him in the first two chapters of his
work. In our examination of the imputation process we shall
attempt to show that recent formulations in accounting theory
are fully consistent with our planning and control hypothesis,
and indeed, fit badly into a conceptual framework which sees
accounting as record-keeping having, as its main object, the
discharge of stewardship obligations, together with a set of
reports to investors. It will be seen that the imputation
problems which have preoccupied accounting theorists are a
special case of the general problem of valuation, which ac-
quires its particular importance through m.anagerial needs
in relation to the planning and control functions.

The greater part of accounting theories deals with
business or corporation accounting, and we shall, therefore,
concentrate on imcputation in the context of the business
firm. We shall then examine to what extent the models of
the firm can be modified to embrace other fields in which
account j.ng is found. The models of the firm, can be clas-
sified into the eoonomia , the financial , and the aybevyietia ."^

The Economis Theory Model of the Firm^

One proximate source of an economic model of the
firm is Irving Fisher, whose ideas recur in the literature
of accounting theory, and who has been expressly cited for
this purpose by Canning and Mattessich, among others.**

- 85 -

Fisher defines v;ealth as "material objects owned by human
beings," and the significance of "material" is that the ob-
jects in question can be physically measured. Valuation is
a species of physical measurement "involving the principle
of exchange," and appraisement is a method of pricing which
supplements actual exchanges in m.arkets. Although an ap-
praisement m.ust proceed from a knowledge of the purpose for
which it is carried out, "price or prices do actually exist
without ambiguity." The physical unit of measurem.ent can
be multiplied by a price, and the resulting price 'data
aggregated to produce values, this last process being wholly
unexplained.

The significance of the phrase "owned by human
beings" is that it incorporates the idea of property rights,
which are rights "to obtain and enjoy the uses of wealth,"
i.e., to future services. It is clear that Fisher is
thinking in terms of consumption as the object of owning
property; property rights are "desirable changes effected
by means of wealth," and desirability is equated with
satisfaction and utility. This construct is not confined
to consumption, however, but extended to investment. "We
may speak of the desirability of a fruit orchard to a
particular person en January 1, 1905, but the pleasure
derivable from that orchard is only to be experienced during
future years, as it bears fruit and the fruit gives en-
joyment to those who eat it."^

- 86 -

Wealth may be a stock or a flow, but income is a
flow of services, i.e., those future services described by
"property rights." Fisher disregards distinctions between
"income," "gain," "profit" and "benefit," and in his later
work this restriction is made explicit, indicating that he
is working with a static model throughout.^ "Income is a
series of events," but they are events of a particular kind;
they are the rights to services enjoyed by an individual;
these services produce satisfaction, so that income is es-
sentially a psychic phenomenon. The services can be taken
to represent psychic income, and money paym.ents for the
services are a surrogate which can be used in economic
analysis .

If we were to try to structure Fisher's tima theory
ox production, it. would probably resemble the constructs used
by Jevons and Bohm-Bawerk. "^ The problem is to describe in
a way suitable for mathematical analysis the process v/hereby
the product of a given quantity of labor increases with
every increase in the "dose" of capital applied, capital
being defined as the intermediate products which are used
in final production. The state of technology is given.
Jevons adds successive units of time to a given amount of
resources, e.g., one month's labor. The amount of investment
capital, which has a tim.e dimension, is divided by the amount
of capital invested, which has no time dimension, to give
the Bchm-Bawerkian "period of production."

- 87 -

Let m' s represent n quantities of physical resources
that are being applied at n points in time t i . . . t to
the production of a consumer's good that is sold and con-
sumed. This involves either identifying these physical
resources with a single homogeneous agent — Jevons and
Bohm-Bawerk chose homogeneous units of labor (subsistence
equivalents) — or the assumption that these resources consist
of doses of invariant composition. For axis we choose time,
and the zero point is the time at which the consumer's good
is sold. The t's are all to the left of this zero point,
hence negative (the expression is made positive by prefixing
a minus sign) and decrease numerically as we proceed from
the first act of investment in ti to the right, tov;ard the
zero point. The expression

m it I + mztz • . • + m t
rn n n

■nil + mz . . , + n

has only a time dimension, since the m's cancel out. This
is the "period of production," the average of the time
distances from the (negative) investment to the sale of
the product. ®

This device permits Fisher to construct a theory of
capital in which capital i.s simply the present value of
income, and the valuation model which results is called
by Canning "direct valuation." Canning contrasts this with
the "indirect valuations" used by accountants, which he

- 88 -

regards as second-best figures, to be used where direct
valuation is impossible or inconvenient. Canning does not
make explicit the assumptions which are necessary in order
to arrive at Fisher's result, and which restrict the appli-
cability of his model to situations in which the process of
production is not of the essence, nor does he discuss the
particular point that, in order for the Bohm-Bav7erkian
structure of capital to be made analytical, this structure
must be comparable physically. It is instructive to trace
the implied model of the firm to its Ricardian origin, in
order to demonstrate the significance of this observation
for accounting theory wnich seeks to explain business or
corporation accounting.

The Ricardian model. Hicks has suggested, is a model
of the fa,rm. Hicks depicts it as follows:

Figure 1. Ricardian Model of the Firm
Sourcs: J. R, Hicks, Capital and Growth (Oxford, 1965), p. 44

- 89 -

The horizontal axis measures output of corn, the
vertical axis, the capital/gross output ratio, both terms
in corn. The length OH is unity, so that the rectangle OHPN
represents the same quantity of corn as input (of capital)
as the output OH. At output ON, RN is the marginal capital/
gross output ratio; given diminishing returns RN is an
increasing function of ON, suggesting a marginal "curve"
AR. At the margin one unit of output (FN = OH = 1) requires
RN of capital to produce it, leaving PR as profit. The
rate of profit PR/RN is a constant, which is shown by pro-
ducing RA backward to meet the horizontal axis at T and
then joining TP, cutting the vertical axis at B; now
BA/AG = PR/RN. If v;e take the rectangle OHPN to represent
total output, the three parts are: (1) OARN , the replacement
of capital, (2) BARP, the profit, and (3) HBPf the rent.
If output must be expanded, N moves the right, the AR curve
is unaffected and therefore T remains the same; TP must
swing downwards, showing that the rate of profit falls while
rent rises.

The theory of the firm in price theory was
substanhially modified in the 1930 's, but it is probably
correct to state that the earlier Ricardian model remained
a formative influence throughout the first half of the 20th
century.^ We shall not attempt to trace the use of this
model in economics, but we shall offer a suggestion as to
how it has been used by accounting theorists.

- 90 -

$ per unit

pital + Labor + Land

Capital + Labor ^******«««,^

Goods or Services

Capital

Q/t

*>^ .agtOiAa^a--*n-jfcTU*tfcqa.iSMM

Inputs (in output
equivalents)

Output

Q/t

Figure 2, Static Price Theory Model of the Firm

Figure 2 shows a different presentation of the firm
of micro-economic theory. It is assumed to be small enough
to conteniplate an unlimited supply of homogeneous inputs of
capital and labor at prices unaffected by the volum.e of
its output. Land, however, is a set of fixed quantities
of varying qualities, displaying the characteristic of
diminishiiig returns, and expansion raises the price of
land relative to the unit of output until the margin, where
the cost of production equals selling price, and beyond
which output will not be taken. The model is conceived
in stock terms; in flow terms it might be viewed as in
Figure 3, where we use accounting terminology to describe
the factors of production. In this new model, materials

- 91 -

inputs are included which are abstracted in the previous
model on the grounds that they cancel out in aggregating
all firms in order to demonstrate the workings of the
economy as a v.'hole. "Expense" is a residual category
embracing interest on capital, rent and other factor in-
comes, as well as depreciation.

Sales

mn —

Materials
+ Labor
^' Expense
(r£;sidual
category)

Q/t

Output

Figure 3. Managerial Decision Model of the Firm

A landmark in this process of utilising the
"see-through" model of the firm was Henry Hess's invention
of the break-even chart in virtually the sarie form as

- 92 -

Figure 3, but classifying costs into "fixed" and "variable"
in relation to specific production decisions, rather than
according to their factor income descriptions.^" This
model patently underlies much of the literature on managerial
accounting which has appeared in the last two decades. ^^

Thus, as shown in Figure 3, quantification in money
terms of the Ricardian comparison between input and output
quantities permits "income" (profit or loss) to be ascer-
tained as a difference; this is Paton's "matching" concept,
which corresponds with the idea of profit in economic theory
as a residual income. ^^ The measurement process relies upon
the output market to quantify outputs and the input markets
to quantify inputs, although Paton v/as prepared to depart
from the latter rule in certain cases.

The accountant makes certain important assumptions in
connection with costing and valuation. In the first
place, he assumes that cost gives actual value for
purposes of initial statement . . . . Cost is the only
definite fact available when a property is purchased,
constructed or otherwise, acquired. ... He assum.es
that every exchange is fair ... in the absence of
definite evidence to the contrary the accountant has
every right to treat initial value as equivalent to
cost. . . . Later, if substantial evidence of depre-
ciation or original loss is adduced, it will be time
enough to revise the original figures. ... An initial
record of total cost would, of course, be necessary
even if cost and original value were not identical. . . .
However, if it immediately became evident in any case
that the real value were greater or less than cost,
the profit or loss would be recognized at once.'^^

We see from this the assumed equivalence of value

in exchange and value in use which underlies the assimilation

- 93 -

of "cost" with "payment" and is one of the several meanings
of "cost" to v.'hich we alluded in Chapter II. We also see how
the introduction of time into the model as an express
variable establishes a necessity to distinguish between
these two value concepts.^'* Since time is abstracted from
the micro-economic model of the firm, in equilibrium the
proceeds of sales (revenue) can be imputed directly to the
factors of production (costs) in order to determine their
values, and the only way in v/hich time can affect the result
is by a delay in the transmission of receipts from the output
market to the firm; this is handled by means of a discounting
algorithm. A disequilibrium situation postulates the in-
equality of revenue and costs, the consequent difference
betvreen which is classified as a "quasi-rent" or a "profit,"
d-epending upon whether it is imputed to a factor of production
or accrues to the entrepreneur as a residual. Time does not
enter into this process of imputation. In the accounting
analysis of the firm, however, there is an additional delay
recognized between the acquisition of the factors of pro-
duction and the output of goods and services, and the problem
of valuing factors in relation to their uses becomes critical.
When we recall the many assumptions of price theory which are
incorporated into the micro-economic model of the firm., it .
will be seen that the imputation problem now assumes a
complexity which calls for a quite different approach.

- 94 -

In order to accommodate this problera in the
framework of his profit (or income) determination process
of matching costs with revenue, Paton introduced the con-
cejJts of cost "expiry" and "attaching." Since cost first
and foremost designates an acquisition, all costs can be
viewed as assets, defined as valuable objects or property-
rights owned by the firm; value is measured by market price.
During the time the asset is held by the firm, which is a
consequence of the superiority of "round-about" methods of
production, its value may change through exogenous or
endogenous causes, the latter of transformation or waste
(loss to the "entity") . This process of (negative) value
changes is designated "cost expiry," and describes the basis
for accounting operations converting an asset into an expense
(.cost) . A positive value change characterizes the exterior-
ization of the product on sale.

We can thus identify three classes of value change
to be recognized by accountants:

1. Valuation adjustments (appreciation or depreciation
of land, equipment, supplies or securities) .

2. Losses through waste, and windfall profits and
losses.

3. Transformations.

Valuation adjustments and windfalls, arising
primarily from changes in expectations, are to be dealt
with on an ad hoc basio; only depreciation is formally

- 95 -

included in the scope of the theory, and although Paton
lists several examples of other adjustments, he purposely
avoids the general problem of revaluation.^^ Losses and
transformations are brought under the doctrine "costs
attach"; by making a metaphysical assumption, Paton sees
the value represented by costs as flowing in some unspecified
way into the objects for which the costs were incurred:
processes, products, and ultimately, the act of sale.^^
Accounting operations relating to this internal flow of
values are rationalized as a recognition of this "fact" of
attachment, so that the valuation of work in process, in-
ventories of products and cost of sales is linked directly
with "costs" as the acquisition prices of factors of
production.

The metaphysical aspects of this doctrine, with
its overtones of hypostatization and reifi. cation, are m.ost
clearly brought out in Paton and Littleton's influential
monograph on the theory of corporate accounting. ^ ^ Accounting
"roots," "traces," "keeps step," "exists"; costs "adhere,"
"trace," "express," "become," "await their destiny," "have
a natural affinity for each other," "cling." The model to
which we are to refer these statements is nowhere described,
and it is quite im.possible to follow the train of thought
which leads from them to the principles or "standards" of
accounting to v/hich they purport to lead. V7e conclude that

- 96

the necessary step of articulating the model of the firm
has not been undertaken.

Paton's theoretical constructs V7ere used by
Littleton as the basis for his considerable contribution
to accounting thought. Littleton adopted an evolutionary
approach to his subject, giving accounting theory overtones
of adaptation to the environment which echo Sombart, and
possibly suggesting thereby a biological analogy which has
been taken up by Chambers, among others. Deinzer has called
this organic viev; a "coherence point of view for establishing
the verity of accounting doctrines ." ^ ^ It may be noted that
Paton shov/s evidence of a similar organic viewpoint, for
example when he states that double-entry bookkeeping is the
only system which can accoian.iodate all the economic aspects
of a transaction.^^

Nevertheless, Littleton V7as acutely conscious of
a need to construct a theory of accounting which would
demonstrate and support the usefulness of financial state-
ments as a record of stewardship. On the one hand, he took
as his point of departure the same economic concepts as did
Paton; on the other hand, he wanted to relate them to a
concept of the firm which went beyond the abstract construct
of price theory. He, therefore, adopted the empirical ap-
proach of observing accounting practices and attempting to
make generalizations concerning them.^' He sav/ the meaning

97 -

of accounting theory in the critical examination of beliefs
and customs in order to direct attention to the "genesis and
outcome" of accounting work. Practices were facts and theory
consisted of explanations and reasons, and one objective of
theory was to furnish explanations of seeming inconsistencies
in practice. ^^ The tools of accounting theory were defini-
tions, reasons, principles and concepts, and a principle was
a "concisely worded generalization of considerable use-
fulness."^^

The most important of these principles was the
"principle of invested cost" which was a requirement to
value accounting observations at prices measured at the
time of a transaction. This idea was merged with Paton's
"matching" concept to formv a "realization principle" which
states that income determination results from a comparison
of invested cost, or input market price, with sales revenue,
or output market price, so that there can be no income
(profit) without a sale.^^ This v;as a slightly different
use of the word "realization," which had previously
designated the rule that revenue from sales v/as recognized
on the basis of invoiced deliveries, which then became the
definition of sales. It has been suggested that one of the
factors leading Littleton to this result was the series of
Federal tax lav/ cases, culminating in the Eisner v. Maaomber
decision, requiring a "severance of income from capital"
for income to be taxable.^**

- 98

This model, which is fully compatible with the
micro-economic model of the firm, permitting sales proceeds
to be im.puted directly to factors of production, led
Littleton to the use of input market prices for valuations;
we shall see that the same model led Chambers in precisely
the opposite direction. However, it did not provide an
approach to valuation in situations to which the underlying
assumptions of the Ricardian model do not apply. ^^ This
appears from May's reply to Littleton's advocacy of "invested
cost," which, again, does not advance our search for a more
useful model. ^ ^

Chambers' contribution to accounting theory is
notable in several respects; in particular, he has tried
to substitute the human "actor" for the metaphysical "entity"
as the centerpiece of the field of study (v;ithout, however,
being able to maintain this viewpoint beyond the first as-
sumption stage) , and he has demonstrably accepted the need
for a theoretical structure which embraces charitable,
government, social and international accounbing as well
as corporate accounting . ^ ' But he , more than any other
accounting v;riter. demonstrates a naive acceptance of the
characteristics of the micro-economic m.odel of the firm.

The evidence is fairly substantial, particularly
in the more extensive treatment of his ideas in a book-length
work. A consumption model of the firm is suggested by the

- 99

fact that the individual's "satisfactions" provide both a

point of departure and a point of arrival,^® persons are

represented as homeostatic systems, although this construct

does not appear essential to his thesis. The use of a

static equilibrium model of the firm is also implied by

the following passage:

. . . in any limited situation, and most action situations
are limited, the wider reference systems in which we act
and the valuations we attach to them may be taken as
given. They may be regarded as implicit in the system;
as being held in comm.on, at least by those members of
the society with whom one interacts; and as having a
considerable degree of stability through time.^^

A discussion of "utility" in relation to means is
remarkable in that it attaches directly to inputs those
properties which are discussed in economic theory in relation
to outputs. ^° The latent imputation problem is not made
patent, but the Marshallian and Ilicksian models are given
as sources (in a footnote) without any recognition of the
conceptual problems inherent in this approach.^'' These
conceptual problems are raised in the next section, on
"Employment of Means," which distinguishes technical from
value considerations, but they are assumed to be soluble
by the marginal approach, which is only correct on the as-
sumptions cf price theory.

Chambers' macro-economic model also abstracts from
time^^ and thus fails to distinguish between saving and
investment; the Keynesian distinction betv.-een ex ante and
ex post is not respected. Chambers' description of the

- 100

legal framework is also highly simplistic, so that ownership
is seen as "unrestricted and exclusive control" over means,
recalling Fisher's view of property rights. He does dis-
tinguish the consumer-role from the producer-role^^ but does
not pursue the implications of this duality of viewpoint,
and he goes on to state the conclusions of price theory
without any reference to the assumptions from which they
are drawn. ^'* The Fisherian model is apparent from this
quotation:

Wealth may be considered to be the general capacity for
satisfaction represented by the things owned by a per-
son; so regarded, wealth is a subjective notion related
to individual appraisals of utiLity,^^

What of the transformation process?

A decision to convert ... is predicated on the
expectation that the product of conversion will yield
a greater price than the means to be converted vrauld
yield if sold.

Remote yields, of course, are to be discounted to
present values. But all this is a belief; producti.on
processes frequently cause saleable comniodities to be
converted into unsaleable forms, so that this argument
applies to the whole process r not to any part of it.'

The money calculation is used only in order to
resolve the "questions of when and whether to buy or sell."^^
"For a person or association acting in a specific role we
will use the general term entity. It will be necessary
when dealing with particular entities or classes of entity

- 101 -

to stipulate the rights, powers and obligations which attach
to it. . . ."^^ The absence of a reference to organization
or process will be noted. Now the entity is personified:
"A person has only one position in relation to his envi-
ronment at a point in time" and to know this position is a
necessary condition of success in acting. Thus, an actor's
position is uniquely determined, and is essentially a
position found with reference to markets; Chambers calls
this "financial position," defined as "the capacity of an
entity at a point in time for engaging in exchanges.""^
The financial position of an entity may not include any
anticipatory calculations, since future prices are not
susceptible to independent corroboration, and all results
and inferences from them are "individual and subjective."

The key to understanding Chambers' approach to
valuation lies in his assumption that objects and events
can have "monetary properties," which they acquire by ex-
changes in markets. "*" Numbers of monetary units assigned
to events and nonmonetary things are prices, and prices are
determined in the market (although revaluation is permis-
sible for durable goods, as with Fisher); they are, there-
fore, objective measurements. In these circumstances, the
accountant could use either buying price or selling price,
but the former does not indicate financial capacity; he
should, therefore, use "market selling price," called

- 102

ourrent cash equivalent . Where no resale market quotations
can be found, hov/ever, input market prices can be used as
a matter of expediency, and this point of view, v;hich echoes
Canning, raises anew the question: by what means can we
move from the idealized market situation of the Fisherian
model to the real world in which accountants live and work?

Chambers, like Paton and, to a lesser extent,
Littleton, is not concerned with this real world in his
theoretical iiivestigations ; indeed, the object of his in-
quiry is the practice of accounting and not the process of
production, distribution and consumption. "* ^ Kis inquiry
results in a definition of accounting which will sit easily
with his image of economic reality: "Accounting is a m.ethod
of retrospective and contemporary monetary calculation the
purpose of which is to provide a continuous source of finan-
cial information as a guide -co future actions in markets. '*^
This functional definition indicates a concern with pricing
rather than planning and evaluation of a process of production,
which is again evidenced by his repeated (and incorrect) as-
sertion that accounting abstracts from all properties of
things except correspondence to money value.

A numh'er of works on accounting theory proceed from
the same "utility in consumption" behavioral assumptions and
the price theory model of the firm; in particular, Gilman,**
Edwards and Bell,'*'* Mattessich, "* ^ and Ijiri.'*' They also

- 103 -

demonstrably fail to articulate the model in such a way as
to provide a basis for explaining the methodology of ac-
counting and the accounting concept of value, and the main
thrust of the later works is toward an algebraic expression
of double-entry bookkeeping rather than research into
valuation models.**^

The Financial Model of t?ie Firm

The "see-through" model of the firm is clearly
inadequate as a representation of the realities of pro-
duction, which becomes quickly apparent when the writers
discussed proceed to attempt to explain particular aspects
of accounting m.ethodology; it is obviously insufficient to
support the precepts and examples of accounting textbooks
or the detailed practices of public and private accounting.
As Machlup points out in the paper cited, if we study the
grovjth of the firm, the organization and some of its
properties and processes are the very objects of the
investigation. His comment that the firm in accounting
theory is a collection of assets and liabilities is not
acceptable here, since these terms are themselves concepts
which require certain beliefs about reality, and if we
define them as property rights and claims we are back in
the Fisherian framework.**® Even if we postulate a circular
flow we shall require a more detailed image of reality than

104 -

these juridical concepts can provide. One such image is
the financial model depicted in Figure 4; that the model
is used by business corporations is indicated by Figure 5,
which v/as developed by General Electric (GE) , a corporation
v.'hich has a long history of research and experirnentati on
with the form and content of published financial statements.

The image of the firm as a receptacle containing
a "liquid" substance representing purchasing power recurs
in the literature on corporation finance and conceivably
informs the comments of writers on accounting, particularly
those who define "costs" as "payments."**^ The reference is
to a narrow concept of finance as "means of payment," linking
up with legal and social uses of the term "liquid capital"
to denote undifferentiated purchasing power. Such an image,
while of undoubted utility as a pedagogic device, leads
subtly to the metaphysical assumption that there exists
some physical substance, having properties akin to those
of liquids, which circulates through a business firm and
which can be "measured" in the scientific sense of the word.
Such an assumption is patently false, since v/hatever liqui-
dity characteristics money as such may possess are of little
or no significance to the processes of the business firm.
Furthermore, the assimilation of acquisitions to uses, which
is a coimnonplace simplification in economic theory, is un-
tenable when we consider the organization and processes

- 105 -

CASH flW TimOICT A EU5II1HSS

Lenders of M^ney
Short Tpim I Long Ten

Pvtichasars of
Csplt«l Stock

Dlvl<J«rrf»

fciccna taxtt j

Cs>h

/ ■.,—. A *** Selling and AdTilni&tratlvc ^^""^V

osts

Finished GooJs
(At Cost)

Flnls!iKJ GooJt
(At &ale» price)

Figure 4. Model of the Firm

Source: John A. Griswold, Cash Flow Through a Business
(Dartmouth: The Amos Tuck School of Business Administration,
1955) , p. 2.

- 106 -

M
■H

■p

M-l

•

•H

-H

S
O

107 -

of the firm/ where the phenomenon of durable goods must be
accommodated, and the GE diagram demonstrates graphically
the ensuing dilemma where it shows depreciation "flowing"
into inventories . ^ °

The problem, arises out of the observation that
there are three separate financial "flows" through the
business, using the word "financial" to mean "capable of
expression as values." There is the long-term, or capital,
flow, the rate of which determines the capacity of the
business to fulfill its economic objectives; the periodic
or revenue flow, the rate of v^hich determines the level of
activity; and the cash flow, the rate of which determines
the day-to-day viability of the business. This last is a
"flow" of means of payment, and is certainly a critical
factor; if the cash flow is inadequate, the business will
die. But the cash flow is not the determinant of either
capacity or activity; if the capital and revenue flews are
strong, and if a money market is available to the firm, then
cash flov7 can be maintained at a rate adequate for survival.
The causal relation is inverse: the capital structure and
the revenue flow are the determinants of the cash flow,
given the existence of a money market.

The necessity to observe cash flow as a separate
and subsidiary financing problem arises from the nonsynchro-
nization of the three value flows, the rates of which can

- 108

and do differ in all but a minority of business firms. The
sources of the divergencies between them can be summarized
as follows:

1. Payments in advance

A. Acquisitions which will become expenses (even-
tually, costs) as the goods and services ac-
quired are used.

, a. Depreciable fixed asset, or equipment,
purchases.

b. Research and development expenditures, and
construction of own equipment,

c. Supplies of materials, parts, fuel, etc.

d. Advance peiyments for future deliveries of
goods and services.

B. Payments whj.ch V7ill produce corresponding
receipts at some future date.

a. Nondepreciable fixed asset purchases.

b. Loans advanced.

c. Investment securities purchased.

2. Payments which correspond with previous receipts,
e.g., loan repayments.

3. Revenues which have not produced corresponding
receipts, e.g., sales on credit.

4. Expenses which have not produced corresponding
payments .

A. Purchases on credit.

B. Expense accruals.

C. Tax accruals.

D. Imputed costs.

5. Receipts which will produce corresponding payments
at some future date, e.g., loans received.

- 109

6. Receipts which will become revenues as the goods
and services to which they relate are delivered
by the firm.

7. Noncash capital or revenue transactions.

A. Goods or services transferred to the firm as
contributions of capital by proprietors, or as
loans by lenders, or in payment for goods and
services delivered.

B. Government and other subsidies in kind, of a
capital nature.

C. Government and other revenue (operating) sub-
sidies in kind.

The three forms of accounting statement which attempt
to summarize these three flows of values are, respectively:
the balance sheet (capital flow), the income statement
(revenue flow) and the funds statement (cash f lov:) . Con-
centrating on the last of these, their interrelationship
can be seen from the cash flow statement illustrated in
Figure 6 .

The financial model of the firm, although it can
be fitted to the underlying reality of business operations
only with great difficulty, represents an advance upon the
pries theory model in this context, because it is conceived
in flow terms. The Fisherian model fits the relation ex-
pressed by the accounting "basic equation" :

Assets = Equities (1)

whereas the cash flow model fits the expanded equation:

Assets + Costs (expenses) = Liabilities + Revenue

-!- Proprietors' Capital (2)

- 110 -
CASH FLOW STATEMENT

FOR THE YEAR ENDED .

Cash was received from :

Net income after taxes

Add: Noncash expenses, e.g..
Depreciation
Bad debts written off
xAmortization of goodwill,
formation expenses, discount
on issue of loan, etc.

Add: Decrease in noncash assets, e.g.
Accounts receivable
Inventories of raw materials,
work in process and finished
goods
Investments
Loans to others
Fixed assets sold
Increase in liabilities, e.g..
Loans received
Accounts payable
Taxes and dividends payable
Proceeds of capital issues

Total Cc;sh inflow

Cash was used for:

Increase in noncash assets, e.g,

Accounts receivable

Inventories of raw materials,
work in process and finished
goods

Investments in securities

Loans to others

Purchase of fixed assets
Decrease in liabilities, e.g.,

Loans repaid

AccounLs payable

Taxes and dividends payable
Repayment of capital

Total cash outflow

Net cash (in) (out) flow

See Income Statement

Included in Income
Statement

Available from
comparison of
opening and closing
balance sheets

Difference between
opening and closing
balance sheets —
cash funds only

Figure 6 . Cash Flow Statement

- Ill -

from which we return to the basic equation by cancellation
(matching costs against revenue), to produce:

Assets = Liabilities + Proprietors' Capital (3)

and

A (Assets - Liabilities) = A Proprietors'

Capital (4)

Equation (4) is a definition of net income on the
assumption that no contributions or withdrawals of pro-
prietors' capital have taken place.

It would appear from the priority given to liquidity
aspects of the balance sheet that this model presupposes an
emphasis on the stewardship objective of accounting, v/hich
would be understandable in the light of the new importance
which published financial statements had acquired for re-
porting to investors. This model also suggests that the
balance sheet is being made to serve a. dual purpose, by
drawing attention to features which would be more clearly
disclosed in a funds statement. It is noteworthy that
references to this model first appear at a time when the
income statement was beginning to acquire an importance
equal to that of the balance sheet, and also when the first
funds statements were being published. ^^ The preoccupation
with liquidity in balance sheets is still acute; not only
does the typical U. S. corporation begin its balance sheet
with this item (than which no piece of information could

- 112 -

be less significant) , but a recent study which draws
repeated attention to the inadequacy of a concept of
liquidity as a basis for balance sheet classification
ends by concluding that working capital should be clas-
sified into monetary assets and unexpired costs. '^ Yu has
shown that this classification is relevant to the funds
statement, not the balance sheet. ^^

We can also observe the implied use of the financial
model in the accounting profession's approach to the prob-
lems posed by fluctuating price levels. The prevailing
view, not only in the United States but in other countries
as v/ell, is that input market prices have continuous rele-
vance to objects of valuation at all points in the production
and distribution process prior to "realization," or exte-
riorization through an act of sale. The "money costs" or
acquisition prices are transcendental forms of purchasing
power, "in suspense" while the operations of the firm are
being undertaken; by a speleological analogy this purchasing
power appears to go underground, to return in the form of
receipts from sales only at the conclusion of the operating
cycle. The effects of price-level changes are, therefore,
seen to have purchasing power significance, and restatem.ent
of the so-called "historical costs" by application of an
index of general purchasing power will thus permit financial
statements to be expressed "in terms of current dollars."***

- 113 -

This approach has recently been adopted by a leading firm

of Certified Public Accountants.^^

In this connection, we may quote a specialist in

the field of corporation finance:

It is useful, I think, to speak metaphorically of the
invested funds of a firm as a pool of some liquid, say
a cup of coffee. As it enters, it has sharp boundaries
and can be distinguished, just as a lump of sugar can
be identified in the cup of coffee — but not for long.
The dissolving of the sugar can be compared to the
sinking fund aspect of a project — the funds thrown off
become an identifiable part of the pool. "Of course,
the coffee will become just as much sweeter as the
sugar added, as those who prefer marginal analysis are
correct in pointing out. Nevertheless, confirmation
of the idea that the funds of a project are soon part
of a pool can be furnished by any cost accountant who
has tried to design a system to follow the results of
projects once they have become a part of a firm's
operations. The almost unsurmountable difficulties
of this task reflect the merging of the project with
other activiries in the firm; they are not simply dif-
ficulties caused by technical matters of accounting
procedure. ^ ^

The accountant's difficulty, according to us, arises

from the use of a narrow financial model of the firm which

depicts only one aspect of reality, and a secondary one at

that. There is no possibility of deducing from this model

any rules which will permit assets to be distinguished from

costs, or revenues from equities, other than by referring

to metaphysical ideas of physical "flow" or "attachment."

The central problem of valuation is uneasily handled by the

"historical cost" rule, which im.plies (a) that money payments

are the only relevant value phenomena to be considered by

the accountant, and (b) that these payments can be uniquely

- 114 -

associated with the objects of the firm's organization and
processes throughout its capacity and operating cycles.
Neither of these assumptions is tenable in the light of
empirical observations to the contrary. The model, there-
fore, has nothing to say on the critical accounting questions
of depreciation, inventory valuation and tax allocation, and
has failed to provide a conceptual framework in the fields
of cost and management accounting, where financial accounting
theory is said to be inapplicable. The consequence of using
this model is seen from financial accounting textbooks to be
a catalog of valuation methods and bookkeeping procedures
which fail to display any connection with the conceptual
framework from which they purport to oe derived. It is
this lack of any logical nexus which drove Paton and
Littleton backward into the arms of Fisher; other accounting
theorists have found more contemporary embraces alluring.

The Cubernetias Model of the Firm

The term, "cybernetics" is used here to designate
all those accounting theories which proceed from the con-
cept of an information system of which an accounting system
forms part. The model has two aspects, a behavioral and
a mechanical; the behavioral aspect is that the firm is
conceived as a formal association of human individuals,
and depicted in the form of the organization charts so

- 115 -

beloved of accounting textbook writers; the laechanical
aspect is the representation of the firm as a decision-
unit, the formal structure of which resembles a computer
program. An increasing number of books and periodical
articles adopt this approach to accounting theory.^'

The various behavioral models of the firm used
by organization theorists such as Barnard, and Cyert and
March, would appear to have little interest to an accounting
theorist who abstracts from behavioral factors; we regard
the human problems of organization as separable from the
processes of production. It is true that budgets can be
conceived as tools for delegating authority, and that a
firm can then be structured as a set of "responsibility
centers," leading to a concept of responsibility accounting
which has received substantial support from^ practitioners
as well as theorists. The difficulties, hov/ever, are real:
each individual presumably displays different behavioral
characteristics, which are not necessarily those presupposed
by the organization chart — Barnard and others have drawn
attention to the distinction between formal and informal
organization. Changes in organization are inclined to
take place frequently, and to be less than perm.anent in
nature, leaving the organization chart limping slov/ly in
their wake. The responsibility centers may not be truly
independent, and the valuation problem, lies at the roots

- 116 -

of all transfer prices. Some individuals have multiple
responsibilities; some centers have more than one responsible;
and so on. V7e are inclined to agree v;ith Machlup that little
analytical utility attaches to behavioral presuppositions
in this context, and we believe that the usefulness of
responsibility accounting systems must be a function of
the extent to which the responsibility centers (and the
related "profit centers") are selected to correspond with
the de facto organization and processes of the firm, rather
than with de jure titular responsibilities.

The decision-unit model of the firm, in fact,
abstracts from behavioral properties other than these
embraced by communications theory, and depicts the firm
as a computer program representing its information flow,
a-s in Figure 7. The organization and processes of the
firm are again abstracted, on the grounds that the ac-
counting system must conform with the requirements of a
hypothetical decision-maker who functions in the same way
regardless of his situation. The conceptual framework
underlying this model was described by a Committee of the
American Accounting Association in 1966^® and has been
called an "events" approach to basic accounting theory. ^^

In this model, accounting is not limited to cash
flows, or transaction data, or profit-making entities;
indeed, it is not even limited to observations which can

- 117 -

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- 118 -

be quantified in money terms. The object is to produce
information which is useful in economizing, i.e., in using
scarce resources, and the all-inclusive criterion of any-
standard or rule is the usefulness of the information to
which it leads. Basic standards would permit accountants
to accept or reject particular accounting methods, and the
Corrimittee found them to be four in number, viz.: relevance,
verif lability ,- freedom from bias, and quantif lability .
These guidelines are consistent with basic communication
theory, which would also accommodate the possibility of
"trade-offs" between the standards in problem situations.

It is no doubt salutary to be reminded that the
publication of financial statements or managerial accounting
reports is an exercise in communication and not an end in
itself. The concealed weakness of the "events" approach,
however, lies in its implication of the information system
as a Bing an si oh. "Undoubtedly, the unsophisticated person
thinks in terms of 'systems' and 'principles.' . . . Popular
ideas tend to be formalistic and to mistake the form for
the reality. ... In reality there is no such thing as a
system. ... It is at best an analytical tool for analysing
social phenomena. . . . Economists are on safe ground as
long as they describe actual events and their causal con-
nections, and as long a~ they examine the effects of certain
clearly defined 'interventions' under specified conditions."

- 119 -

The concept of a financial information system as a part of
a total information system, and the application of communi-
cation theory to these concepts, must be structured by
reference to some underlying reality observable in firms
and other economic units, and not by analogies with the
natural and other social sciences.

The problem would be otherwise if we were able to
identify some conceptual framework — call it "General Systems
Theory" — ^which had been seen, through appropriate scientific
inquiry, to apply to all fields of human knov;ledge; a
science like logic or mathematics. On close examination,
however, the possibility of such a construct is transformed
into an "interdisciplinary approach" similar to the one to
which we are ourselves coirimitted. ^ ^ True, the homeostatic
model used by Chambers and others could conceivably represent
a universal "system/' possessing the characteristics of a
computer; it is unlikely, however, that this model represents
any economic reality, or if it does, empirical evidence to
that end has not yet been produced. ^^ It is more likely
that the computer is simply a machine which is capable of
performing certain routine operations than that it is a
microcosm of the universe.

Wiien we read that "There is a growing tendency to
define organizations as information entities or systems,
and information processing as their major function, "^^

- 120

we know that we are again in the realm of concept rather
than belief; just as Littleton and Chambers are studying
"accounting," so the information theorists are studying
"cybernetics." The problem involved in using the infor-
mation system concept is its open-endedness , as Moonitz
has pointed out;^'' the idea of providing the decision-
maker with the inforniation necessary for his decision is
not operational. Computer technologists are becoming
increasingly skeptical about the value of systems designed
for information production, if only because managers cannot
specify what information they require. Updating the data-
base and other human aspects of the problem are insignifi-
cant in comparison with the major obstacle provided by the
absence of an image of a reality to which the phrase
"management information system" can be referred. IBM,
for example, recently experimented with a highly sophisti-
cated "management information system" at its Armonk, New
York, headquarters, but it was soon discovered that managers
did not bother to use it, apparently because it did not
provide the information they needed in a form they could
use.^^ Since information is defined as "purpose-oriented
organized data,"^^ and, since we require both a defined
purpose and certain beliefs about the realities to be
planned if we are to utilize the idea of a "system," the
computer has to be programmed accordingly. If we understand

- 121 -

a production process, we can program a computer to control
it; if we understand the organization and processes of the
firm, we can likewise express them, in the form of flow
charts and block diagrams, so that a computer can be
programmed to plan and control them. So far, the accounting
theorists who make use of the information systems or cyber-
netics model have not attempted to describe the firm to
which their programs will apply, although Bedford has
come very close to stating the problem as explicitly as
we are doing here.^^

Conclusion

We have attempted to show, not only that the price
theory model of the firm in its Fisherian formulation lies
at the base of the structures erected by a num.ber of recog-
nized accounting theorists, particularly those whose
influence we regard as paramount, but also the reasons
why it is out of place in this context. The model is, of
course, an economic decision model, and, therefore, would
conform with the initial assumption made by us. The
cybernetics model is likewise a part of decision theory,
and is being used increasingly by accounting theorists
whose orientation is "managerial" rather than "financial." .
The financial, or "cash flov^," model of the firm appears
at first sight to be better suited to a stewardship view

- 122 -

of the function of accounting; on closer examination,
however, it reveals itself equally compatible with a plan-
ning or a pure control hypothesis , ^ ^ In the next chapter,
we shall attempt to construct a planning model which is
free from the deficiencies of those already examined.

NOTES

1. See A. C. Littleton, Accounting Evolution to 1900 (New
York: American Institute Publishing Co., 1933), p. 320;
S. Paul Garner, Evolution of Cost Accounting to 1925
(Alabama, 1954), Ch. I. Littleton's "Accounting Redis-
covered," The Accounting Review, Vol. 33 (April, 1953),
pp. 246-55 emphasizes the recording function although
seeing it as a managerial requirement.

2. We do not overlook the legal sources of accounting theory,
but we regard it as improper to confuse juridical and eco-
nomic concepts in a work on accounting theory. Juridical
concepts must be taken as given, and are incapable of
analysis outside a work on jurisprudence. For explora-
tions in this field, see A. C. Littleton, Accounting Evo-
lution to 190 0, and Essays in Accounting (Urbana,
Illinois, 1961); also Arthur H. Dean, "The Relation of
Law and Economics to the Measurement of Income," The Ac-
counting Review, Vol. 28 (July, 1953), pp. 328-42. See
also a series of articles by Sidney L Simon in the sam.e
journal, 1953-56.

3. The reliance of accounting theorists on a :nethodology
devised by 19th century economic theorists for a totally
different purpose has been demonstrated by James T. Robey
in The Economic Standard for Contemporary Accounting
Theory Formulations : Some Implications of Changes in the
Methodology of Economics , Doctoral Dissertation, Florida

(1969). The first section of this Chapter pursues Robey's
argum.ent in a different direction from the one selected
by him.

4. Irving Fisher, The 'Nature of Capital and Income (New York:
The Macmillan Co., 1906) and The Theory of Interest (Nev;
York: The Macmillan Co., 1930).

5. Fisher, The Nature of Capital and Income, p. 43.

6. Fisher, The Theory of Interest , p. 28.

7. See J. A. Schunipeter , History of Economic Analysis (New
York: Oxford University Press, 1954), pp. 905-9.

8. For an illustration of Fisher's use of this construct, '
see The Theory of Interest , pp. 64-5,

9. See Fritz Macnlup, "Theories of the Firm: Marginalist,
Behavioral, Managerial," American Economic Review,
Vol. LVII, No. l" (March, 1967), pp. 1-33, espec. p. 3.

- 123 -

- 124 -

10. Henry Hess, "Manufacturing: Capital, Costs, Profits
and Dividends," Engineering Magazine , Vol. 26, No. 3
(December, 1903) , p. 367 et seq.

11. E.g., Harold Bierman and Allan R. Drebin, Managerial
Aooounting : An Introduction (New York: The Mac-
millan Co., 1968); Nicholas Dopuch and Jacob G.
Birnberg, Cost Aooounting (Nev7 York: Harcourt,
Brace & World, Inc., 1969).

12. Frank H. Knight, Risk^ Unoertainty and Profit (Nev7
York: Harper Torchbooks , 1955).

13. W. A. Paton, Accounting Theory (A.S.P., 1962)

(original publication. The Ronald Press Co., 1922),
pp. 489-90.

14. Paton distinguishes the concepts "expenses," "cost"
and "loss," but his terminology is imprecise and he
consistently equates cost with acquisition price.

15. Paton, p. 42 4.

16. Ibid. :, p. ^91 .

17. W. A. Paton and A. C. Littleton, An Introduction to
Corporate Aooounting Standards (American Accounting
Association, 1940), Ch. II, "Concepts." This mono-
graph attempts to establish the "basic concepts"

or "postulates" underlying previous formulations of
accounting theory sponsored by the Am.erican Account-
ing Association, in which Littleton, in particular,
took an active part.

18. Harvey T. Deinzer, Development of Accounting Thought

(New York: Holt, Rinehart and Winston, 1965) , p. 41,

19. W. A. Paton, "Theory of the Double-Entry System,"
repr. in Fat on on Accounting , ed . H. F. Taggart
(Michigan: Bureau of Business Research, 1964)

pp. 3-18.

20. Deinzer, p. 56.

21. A. C. Littleton, Structure of Accounting Theory

(Aitierican Accounting Association, 1953), Ch. 8.

22. Ibid.:, Ch. 10.

- 125 -

23. See Floyd W. VJindal, "The Accounting Concept of
Realization," Accounting Review, Vol. 35 (April,
1961) , pp. 249-58.

24. See Clifford D. Brov.'n, The Balance Sheet to the In-
come Statement 3 Doctoral Dissertation, Michigan
(1968).

25. See Deinzer, p. 87: "Did Paton and Littleton chart
their passage from the simple concept of business
entity to a pro-position about costs and assets?"

26. G. 0. May, "Limitations on the Significance of In-
vested Cost "The Accounting Review, Vol. 27 (October,
1952) , pp. 436-40.

27. R. J. Chambers, "Blueprint for a Theory of Accounting,"
Accounting Research, Vol. 6 (January, 1955), pp. 17-25;
Towards a General Theory of Accounting (Adelaide, 1961);
Accounting, Evaluation and Economic Behavior (New
Jersey: Prentice-Hall, Inc., 1966).

28. Charabers, Accounting , Evaluation and. Economic Behavior ,
p. 50, p. 53.

29. Ibid., p. 43.
30= Ibid.^ pp. 48-9.

31. There is no imaginable rea^son why the firm should
experience decreasing satisfaction expectations as
its stock of a comjTiodity is increased, although this
may be undesirable if it can be expected to reduce
profits .

32. Chambers, Accounting, Evaluation and Economic Behavior,
p. 52 ,

33. Ibid., pp. 49, 66.

34. Ibid., pp. 67-8.

35. Ibid., p. 70.

36 . Ibid. , p. 73 .

37. Ibid., p. 79.

38. Ibid., p. 80.

- 126 -

39. Ibid., p. 81.

40. Ibid. J p. 85.

41. Ibid., pp. 8-9 and pp. 46-7.

42. Ibid., p. 99.

43. Stephen Gilraan, Aooounting Concepts of 'Profit (New
York: The Ronald Press Co., 1939).

44. Edgar 0. Edwards and Philip W. Bell, The Theory and
Measurement of Business Income (California, 1961) .

45. Richard Mattessich, Accounting and Analytical Methods
(Homewood: Richard D. Irwin, Inc., 1964).

46. Yuji Ijiri, The Foundations of Accounting Measure-
ment: A Mathematical J Economic and Behavioral
Inquiry (Mew Jersey: Prentice-Hall, Inc., 1967).

47. We may mention two important publications of the
American Institute of Certified Public Accountants:
Accounting Research Study No. 1, The Basic Postulates
of Accounting , by Maurice Moonitz (1961); and No, 3,
A Tentative Set of Broad Accounting Principles for
Business Enterprise.-. , by Robert T. Sprousa t?..ad
Maurice Moonitz (1962). These works, which have
been subjected to a substantial volume of critical
comment, appear to have been based on the same type
of model. In this context, see Maurice Moonitz and
Charles C. Staehling, Accounting : An Analysis of
Its Problems , Vol. I (Brooklyn: Foundation Press,
1950) .

48. Machlup, p. 8.

49. E.g., "at cost, that is, at the actual number of
dollars spent or promised ..." in Lawrence L.
Vance and Russell Taussig, Accounting Principles
and Control (New York: Holt, Rinehart and V7inston,
1966) , p. 10.

50. The financial model has also proved attractive because
of its applicability to nonprofit organizations. We
simply remove the flow from sales v;hich replenishes
the reservoir of cash, and substitute for "Proprietors'
Capital" the relevant source of funds, e.g., taxes, or
donations. The model becomes a one-way "flow- through"
representation of the organization.

- 127 -

51. L. S. Rosen and Don T. DeCoster, "Funds Statements:
A Historical Perspective," The Aooounting Review,
Vol. 44 (January, 1969), pp. 124-36.

52. William Huizingh, Working Capital Classifiaation

(Michigan: Bureau of Business Research, 1967).

53. S. C. Yu, "A Flow-of -Resources Statement for Business
Enterprises," The Acoounting Review^ Vol. 44 (July,
1969) , pp. 571-82,

54. This result has been arrived at through a number of
persuasive studies, starting with H. W. Sweeney,
Stabilized Aaaounting (New York: Harper & Row, 1936)
and culminating in the Accounting Research Study

No. 6, Reporting the Financial Effects of Price-LeveZ
Changes (New York: A.I.C.P.A., 1963) and Statement
No. 3 of the Accounting Principles Board, Financial
Statements Re-Stated for General Frice-Level Changes
(A. I.e. P. A., 1969).

55. See Accounting and. Reporting Problems of the Account-
ing Professio'n (3d ed. ; Chicago: Arthur Andersen &
Co. , 1969) , p. 6.

56. Pearson Hunt, Financial Analysis in Capital Budgeting
Harvard: Graduate School of Business, 1964), pp. 13-19

57. See Thomas R. Prince, Extension of the Boundaries of
Accounting Theory (Cincinnati, Ohio: South-Western
Publishing Co., 1963); Hector R. Anton, "Some Aspects
of Measurement and Accounting," Journal of A.cccunting
Research, Vol. 11 (Spring, 1964), pp. 1-9; Norton M.
Bedford and Vahe Baladouni, "A Communication Theory
Approach to Accountancy," T'he Accounting Review,
Vol. 37 (October, 1962), pp. 650-9.

58. A Statement of Basic Accounting Theory, American
A-Ccounting Association (1966) .

59. George H. Sorter, "An 'Events' Approach to Basic
Accounting Theory," The Accounting Review, Vol. 44

(January, 1969), pp. 12-19.

60. G. Myrdal, The Political Element in the Development
of Economic Theory (Harvard, 1955), pp. 197-8.

61. See Kenneth E. Boulding, "General Systems Theory — The
Skeleton of Science," Management Science, Vol. II
(April, 1956, pp. 197-208.

- 128 -

62. For example, which feature of an association of persons
can be designated a servo-mechanism?

63. John W. Buckley (ed.), in Contemporary Accounting and
Its Environment (Belmont, California: Dickenson
Publishing Co., Inc., 1969), p. 339.

64. Moonitz, p. 4.

65. See report by Timothy Johnson in the Business Section
of the London Sunday Times dated October 5, 1969.

66. Peter A. Firmin and James J. Linn, "Information Systems
and Managerial Accounting," The Accounting Review^
Vol. 43 (January, 1968), pp. 75-82.

67. Norton M. Bedford, Income Determination Theory: An
Accounting Framework (Reading: Addison-Wesley , 1965).

68. The duality is apparent in W. J. Vatter, The Fund
Theory and Its Implications for Financial Reports
(Chicago, 19 47) , where management requirements are
given as "the most direct demands" on accounting,
but the exposition is clearly directed toward
financial reporting requirements.

CHAPTER V
AN ACCOUNTING THEORY OF THE FIRM

The psychological processes involved in comiaunications
are not understood even by neurologists; for this reason,
if for no other, a communications theory of accounting is
inconceivable at the present time. The attempt to consider
man in fundamentally biological terms such as homeostasis,
a form of logical error which involves the presupposition
that man is continuous v/ith all other animals except for
the modifications forced by civilization, underlies the be-
havioral approach to accounting theory, v/hich v.'e have like-
wise rejected, "Philosophical anthropology today looks
away from essences of man in order to grasp man in his par-
ticularity and his complexity."^

Just as philosophers and psychologists are
attempting to move, from concepts about man to the image
of man, so must we also endeavor to identify the beliefs
held by accountants concerning some reality of human inter-
course in order to be able to depict a model of the firm.
In this chapter we shall describe the organization and
processes of production which we believe to characterize
the contemporary business firm, in order to postulate a

- 129 -

- 130 -

model of the firm to whd.ch accounting methodology can be
seen to apply. We shall then attempt to relate this model
to other human activities in which accounting is done. The
cyclical movements described will be dealt with sequen-
tially, although it is clear that many of them occur simul-
taneously.

The Organization and Processes of Produation
Investment and Capital

We define investment as the allocation of scarce
resources to production; it is therefore an alternative to
consumption, which is the centerpiece cf economic theory.
"The one term that straddles both se3.f and other, 'produc-
tive,' is the most ambiguous o'F all; it is so far from
being self-evident as to what is 'productive' that every-
thing . . . may be labelled such."^ Nevertheless, v/e are
forced by the logic of our assumptions to take a position
on this question; by combining the concept "scarce resources"
with the function of choosing between present satisfactions
(including the production of present satisfactions) for
oneself and the future satisfactions of others, we hope to
have formulated a belief that "production" constitutes an
acceptable iiriage of reality.

The investment decision per se does not involve
either the acquisition or the use of resources; these follow

- 131

as part of the processes of production. It consists

essentially of identifying and quantifying the resources

required, together with the intention to produce goods or

services for a knov/n or unknown market, which intention

leads to action.

Knight thought that "Whether any particular

individual becomes an entrepreneur or not depends upon his

believing (strongly enough to act on the conviction) that

he can m.ake productive services yield more than the price

fixed upon them by what other persons think they can make

them yield (with the same provision that the belief must

lead to action)."^ We do not find this assumption necessary,

even though the social sanction constituted by a profit

motive or goal is clearly a factor to be considered as part

of the decision process of the entrepreneur. We find more

congenial Knight's later observation on this subject:

It is common to think of the economic process as the
production of goods for the satisfaction of wants.
This view is deficient in two vital respects. In the
first place, the economic process produces wants as
well as goods to satisfy existing wants. . . . The
second point is that the production of the indirect
means of want satisfaction is by no m.eans altogether
directed to the ultimate satisfaction of v;ants in any
direct sense of the terms. . . . It is a great error
to assume that in a modern industrial nation production
takes place only in order to consumption [sic]."*

Thus, we are at one V7ith Knight when he asserts

that the object of the entrepreneur is to create wealth.

- 132 -

but we see the wealth in the goods and services produced,
not in the profit thereby attained, or desired.

The investment decision involves finding answers
to three fundamental questions susceptible to quantitative
3n^.l'V''sis ■

1. What quantity of scarce resources is required for
the tulf.ilment of the postulated economic objective?

2. From what sources are these to be obtained, and
on what terms?

3. Is the fulfillraent of the economic objective (in-
cluding v/here relevant the probability factor)
valued higher than the sacrifices (costs) which
these terms represent?

It is perhaps paradoxical that only in the marginal
situation, where costs and benefits are equal, are the non-
quantifiable value elements likely to prove the main deter-
minants .

The quantification of resources proceeds in money
terms, since the value characteristics of money as a means
of exchange can be transferred to the use of a money scale
for a variety of goods and services required as inputs.
The summation of these quantities produces a set called
capital , defined as a representation in money of the scarce
resources identified by an investment decision. Since the
more common usage is to apply this word capital to the
sources from which the resources are to be acquired, in-
cluding the terms which must be agreed with the persons

- 133 -

involved, we shall use assets to denote what the economist
means by capital; thus capital and investment are not m.ere
identities, the capital of the firm being the investments
of those who provide it, nor are capital and assets iden-
tities, since they are determined by some common and some
separate factors. The confusion which ensues when these
concepts are used interchangeably has been noted by several
distinguished economists, without, however, having been
thereby diminished. Everyday usage likewise substitutes
capital for assets, and we must be aware of this in our
observation of reality.

Business firms acquire capital from proprietors,
lenders and the state, which latter generally fails to make
its position clear in this matter. Presumably these sources
will require certain incentives in order to cause them to
refrain from both consumption and alternative investment;
these incentives are known collectively as the "cost of
capital." The incentive required by any investor should
be at least equal to the benefit lost through foregoing the
next best alternative; this V70uld be as true of state sub-
sidies as of any other forra of capital, except for the fact
that civil servants are under no social obligation to count
costs. A lender will require interest, based upon condi-
tions in the capital market at the time he makes his de-
cision, A proprietor may have no "expectations" as such.

other than that he wil3 be able to share in any residual
income, or profit; if he requires an additional incentive
it will be in the nature of an "opportunity cost" and be
capable of expression as a rate (of return) similar to
interest.

Tne conj.u5j.on oetween capital snd assets Iss.ds to
the further logical error of failing to distinguish betv;een
"cost of capj.tal" and "interest on capital (= assets)," a
common feature of both economics and accounting. That these
two phenomena are separable can be seen from the income
distribution account of a socialist enterprise, reproduced
by Marczewski . ^

Sales 423

Purchases 176

Depreciation 39

Interest on fixed assets 13

Interest on current assets 4

Wages 61

Social Security 27

Profit 103

Total £23

Distribu tion of Profit

40% to Federal Government 41

20% to Republic 21

Reserves 2
Supplement to special

category of workers 9
Supplement to Social

Security 4

Balance of wage supplement 18

Local government 4

Freely disposable by firm 4

Total 101

- 135 -

The statement shows that the two problems are
handled quite separately. The amount of capital required
is determined by the resources to be allocated to production,
and insofar as production has a time element, involves a
necessity to calculate interest. The cost of capital re-
quired is determined by the opportunities foregone by in-
vestors, as perceived by them at the time they decide their
investment. Eva].uation is a process of comparing the costs
of the firm v/ith its revenue, and the costs of capital are
not the costs of the firm, but of other investors-.

Equipment 3 or Investment in Capaaity

The first class of resources identified by the
investment decision is composed of those goods and services
which are required in order to create a capacity to produce.
Like "production," "capacity" presents a problem, and in
order to define it operationally we shall distinguish be-
tween three possible conditions of the firm, the last two
of which are usually merged under the concept "liquidation."
The three conditions are: going-concern, shut down and
abandonment. As a going concern, the firm requires certain
resources to fulfil its economic objective; it can, hov;ever,
operate at varying levels of activity between zero output
(shut down) and some practical maximum. The variable ele-
ments of the total resources required, which may be zero

- 136 -

in a shut-down condition, constitute the "circulating" or
"working" capital (=assets) of the firm; the fixed elements,
which are changed only in order to expand or contract the
practical maximum level of activity, is the equipment com-
ponent. Thus, capacity to produce is defined as the factor
or factors which limit the practical maximum level of ac-
tivity at a given moment in time, and in the abandonment
situation, capacity is zero.

All firms require equipment, although the proportion
of its total resources which a given firm, v.'ill invest in
equipment varies from "very little" to "nearly all," de-
pending upon the technology of the industry and the structure
of its markets; the author needs only a room, of his own and
a typewriter, but an oil refiner needs an oil refinery not
too far from a population center. We must include the tech-
nology of finance in this class of determinants, since the
ability of a society to fractionate investment situations
by institutional devices permits some industries to reduce
investment in equipment, while creating nev; industries with
equipment needs to take their place. The author can rent
both room and typev/riter, whereas oil refiners must still
own their refineries; doubtless, not for long.

Besides the state of technology in the particular
industry, the size and other characteristics of the market
determine capacity. The economic size of a cement works.

- 137 -

that, is to say, the size v/hich permits the production of
each ton of cement at the lowest cost, may be known to lie
at 300,000 tons annually, but whether a cement works will
be built or not, and, if so, with what size, depends upon
the population being considered, its building needs and
techniques, the organization of the building industry, its
financial possibilities and distance from the nearest com-
petitive producer, the location of raw material sources and
many other factors. Further, investment in equipment is
determined not only by the current states of technology and
markets, but by expectations concerning future developments.
A brewery may be constructed with a greater capacity than
the consumption requirements of the area which it is to
serve, and which will produce relatively uneconomically at
levels of activity substantially below capacity, if the
population of the area and its age distribution are ex-
pected to change within a few years in a direction favorable
to the consumption of beer. Again, the possibility of con-
structing a rail transportation system which will be eco-
nomically efficient and serve a large and mobile population
will not result in a corresponding investment if rail use
is expected to decline; a smaller capacity may be selected,
the optimal factors of which will become apparent only
with time. Market features are particularly dominant in

- 138 -

this area, and the relevance of subjective considerations
concerning what is, and what is not, "the market" are clear
and unmistakeable.

However difficult the preparation of the decision,
and there are some who maintain that only in the determi-
nation of capacity does the entrepreneurial skill come into
play, the number, type and nature of the resources which
constitute capacity must be found, quantified in money and
somehow aggregated, in order to find the first component
of the money amount we have called "capital."

Finanae and Working Capital

The second class cf resources identified by the
investment decision is the variable quantity which will be
required to support given levels cf activity. It follov7s
that this part of the decision involves the separate act
of determining the level of activity for a specific period
of time, called the "operating cycle" time, and this level
of activity need not correspond with practical maximum ac-
tivity for the reasons given above. The separation of
"working capital" from "fixed capital" is a principal fea-
ture of the financial model balance sheet; this is under-
standable, since the avowed purpose of this form of balance
sheet was to disclose liquidity as a support for obtaining
credit.^ The decision to clarify the liquidity position

- 139 -

by means of a balance sheet classification arose through
observation of the essentially distinct financing operations
called for by the "fixed" and "variable" aspects of the
firm's investment. Again, the economic distinction between
partial adaptation and total adaptation, which underlies
the separate theoretical treatment of the short-run and the
long-run, can be traced to the same observation.^ The as-
sertion that, because balance sheets are used for purposes
other than the granting of credit, therefore the working-
fixed capital classification has little utility for these
other situations, is a typical non sequitur .'^

The working capital classification was given nev;
life some twenty years ago by its reformulation in terms
of the operating cycle. Dissatisfaction with the -cime-
period rule VJhich liquidity considerations had introduced
led Kerrick to distinguish between "fixed capital," or
"facilities with which to conduct . . . business" and "cir-
culating capital" or "properties in which [the business]
deals. "^^ Unfortunately, Herrick's distinction was like-
wise based upon the concept of rates of flow of cash, so
that the underlying reality with which we are concerned v/as
not brought out either by him or by the official accountancy
bodies which sponsored this viewpoint. The many criticisms •
of the operating cycle approach to working capital classi-
fication which were subsequently voiced are attributable to
this defect.

- 140 -

Since we are contemplating a variable quantity of
resources, however, it is useful to think of them in the
first place in the form of purchasing power, that is, in
the form of bank deposits and negotiable instruments to be
used for the day-to-day acquisition of the factor inputs
which are required for production and can be varied from
one operating cycle to another. This store of purchasing
power will rise and fall with the receipt of the proceeds
of sales and with payments to suppliers of inputs. Certain
factors add to the working capital requirements of the firm,
in particular the supply position, or necessity to store
factor inputs for varying lengths of time, and outputs be-
tween the time when they are produced and the time the mar-
ket is ready to take them. There are invariably good
reasons for both of these conditions; a striking modern
example of the latter case is provided by the hairdressing
industry, v/hich has found it possible to store haircuts
(in the form of wigs) in order to im.prove the productivity
of labor. Credit relations, on the other hand, may sub-
tract from or add to the purchasing power requirements of
the firm, depending mainly upon whether they arise out of
the acquisition of inputs or the disposal of outputs.

Working capital, then, can be defined as the
quantity of resources required by a firm to support a given

- 141 -

level of activity, over and above the quantity of resources
which constitutes capacity. It is determined by the planned
level of activity, which is, itself, in part determined by
capacity, and thus ultimately a function of the product mar-
ket and its technology. In addition, working capital is
determined by such factors as: location, v;hich affects
supply at both ends; general economic conditions, which af-
fect credit relations; and special conditions applicable
to particular firms, such as credit-worthiness, from which
v;e abstract here.

Operations 3 or Costs and Production

So far we have discussed the acquisitions which
characterize preparation for production,- but these are a
function of the planned level of activity and of capacity,
so that they are themselves determined fc)y the operations
of the firm. The objective of the firm has been stated
as the production of goods and services, and its operations
transform factor inputs, each measured in its appropriate
unit, into a finished output, measured in its appropriate
unit. The valuation of these required quantities of inputs
we call "costs." If the costs of a firm are related to
periods of time, rather than operations, we call them "ex-
penses"; in the lindting case, where there is no loss
through v;asto or v/indfall gain, and v:here all inputs used

- 142 -

during a period can be associated v;ith outputs of that
period, costs and expenses are equal. The costs of the
firm are composed of equipment use as well as the use of
input factors acquired with working capital; the valuation
problem is common to both types of input.

The typical firm will recognize costs in a v/ide
variety of forms. The traditional classification into
materials, labor and expense (the last a residual class)
is understandable in the light of its 19th century origins;
the firm of that period used proportionally large quantities
of materials and labor, and small quantities of other fac-
tors. A more appropriate classification of factor inputs
is given belov?; it dis cinguishes between goods and services
used because of the storage possibilities of the form.er,
and between current income distribution and interperiod
transfers, because of the social implications of income
distribution.

1. Goods and services

a. Goods produced by other firms.

b. Services produced by other firms (transpor-
tation, insurance, rent, etc.).

c. Services produced by government (taxes, fees,
licenses) .

2. Current factor incomes
a. Wages and salaries.

- 143

b. Social security charges.

c. Interest on capital (= assets) .
3. Interperiod transfers

a. Depreciation.

b. Research and development.

c. Pensions.

It viill be recalled that we are here considering
the use of goods and services, and not their acquisition,
so that those features of the classification which relate
to acquisition are not essential to the categorization of
the subject matter as costs; this warning is particularly
necessary because of the temptation for the reader to pre-
suppose that all wages and salaries paid should appear in
2a. From the point of view of the user, i.e., the invest-
ment planner, the only significance of this classification
is its relevance to the valuation problem, where it will
prove of great utility.

We must again be careful to avoid the fallacy of
misplaced concreteness. The "liquid flow" image was ex-
tended to the cost valuation problem in a famous and in-
fluential study of the early 1950s, in which the phrase
"pools of cost" was first used.'^^ There are, of course,
no such "pools" in reality, and the introduction of this
image, while it may have served to rationalize a procedure

144 -

and provide advocacy for its adoption, has thrown no light
on the nature of the underlying reality. Accountants sub-
classify processing costs into two principal categories:
"direct" and "indirect" costs, the latter often referred
to as "overheads." Direct costs are those valuations of
factor inputs where the acquisition price of the required
physical unit of input is attributable to the physical unit
of output through the presence of a one-for-one correspond-
ence or isomorphism in a physical sense. The payment of a
royalty to an author, amounting to so much per book sold,
is attributable to the book sold in the form of a direct
cost, as is a pure piece-rate payment for printing labor,
or a specially purchased piece of wood used for making a
print for the book. The purchase of paper for the pages of
the book, if it is one of several thousand copies, is a less
simple case, because of the assumptions which are necessary
to relate the physical quantity of paper purchased to the
physical quantity represented by one copy of the book, and
by this means to take a proportion of the purchase price.
The physical correspondence, or isom.orphism, involved is
only one of the variables which may be accommodated by a
valuation model, however, so that it cannot be said even
in the most direct case that the payment is the cost. Further,
many input factors must be classified as overheads in the

- 145

absence of any such isomorphism, but are no less input
factors on that account, and they have invariably to be
valued as costs by means of a different model, known as the
calculation of an overhead rate.

The object of the production process is to bring
goods and services into the hands of either consumers or
those who will use them as intermediate products in the
production of consumer goods and services. Seen in this
light, there is no fundamental distinction between "manu-
facturing" and "selling" costs, nor is there a separable
noncost area to be designated "administration" or "financ-
ing"; if the organization of the firm calls for these areas
to be grouped under such headings, they are no different
from the other overheads which we have discussed. The dif-
ferences between these categories of cost are purely dif-
ferences of timing; manufacturing costs represent uses of
goods and services in bringing products to a saleable con-
dition; selling costs represent uses of goods and services
necessary to bring saleable goods to their consumers. In
many cases no clear distinction can be m.ade between them,
since to be saleable to a given consumer the product must
be made in a specified way; this observation lies at the
base of marketing management theory. The timing problem
affects valuation, since manufacturing and selling expenses
are rarely synchronous. The financial expense problem is
of a similar nature.

- 146 -

The relationship between the operations of the firm
and its costs of production is shov/n in Figure 8. The
equipment of the firm constitutes its infrastructure, its
organization, a superstructure. Acquisition of inputs via
i.tv^j. j-,.v, ^^ ^j-^^i^euo <-n_ cij-j. j-c:vi^x£), as> uotis use, uu.l. (jury cne
latter js attributable to actual operations. The problem
of valuation lies in the need to distinguish betvjeen goods
and services at various stages in the production process
according to the value they represent to the producer; oven
where a physical flow can be determined, the relation of
acquisition prices to physical units at points in the flow
is rarely isomorphic; the same observation holds for selling
prices, so that Chambers' and other direct valuation models
are equally inapplicable. The idea of a "flow of values"
is an image of an accounting process; if we abstract from
the valuation problem, it is also an image of a real pro-
cess of transformation and eventually exchange. The val-
uation problem can only be approached by first identifying
the real process of transformation and exchange, and its
stages, for each of these stages presents the accountant
with a separate valuation requirement.

Sales Revenue , or Distribution

The final act of the entrepreneur in the operating
cycle is the exteriorii:ation of the good or service pro-
duced, V7hich we usually represent as a sale. This

- 147 -

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- 148 -

fulfillment of the objective of the firm creates the
conditions under which the investment can be liquidated,
i.e., converted into purchasing power; in the majority of
cases, however, reinvestment is automatic, so that pro-
duction becomes a continuum of investment. A sale is an
invoiced delivery; two features must be present, the
delivery of a good or service to a customer (consumer or
other producer) and the intention to recover the value of
the good or service from the customer, manifested by the
submission of an invoice. Liquidation of the sale by
receipt of the purchasing pov/er represented by the amount
invoiced is only one possible consequence of a sale; if it
follows, then this aspect belongs to the financing of
operations, or the "cash flov/" which, as we have pointed .
out, is a separate problem affecting the working capital
of the firm and the manner of its composition.

As expenses are costs related to time periods, so
revenues are sales related to time periods. The "matching"
process is predicated on an underlying reality which relates
both to the same period of time. But the reality under-
lying the act of sale is the transformation of the objects
of the production process into either consumption goods in
the hands of consumers or intermediate goods in the hands
of the producers who are responsible for the next stage in

- 149 -

the production process. These are the goods and services
for which the costs of production v;ere incurred, but we
must distinguish betv/een the various possible outcomes,
as follows:

1. All goods produced are saleable in the current
period.

2. Some goods produced are not saleable.

a. Because there is no market for them (waste) .

b. Because they are to be used by the firm
itself (own machines constructed; samples
to be given away , etc . ) .

3. Some goods produced are saleable in a subsequent
period (inventories of work in process and finished
goods) .

4. Some goods sold ix\ the current period were pro-
duced in a prior period (reduction of inventories) .

■■■ ■—

Production

Increased
inventory

Own
use

Lost

Reduced
inventory

Revenue

Where the object of the firm is given as the
maximization of profit, or "net income," the model assumes
that the value of what is exteriorized will be greater than
the costs, or values of what is used for that purpose. This
is clearly an unnecessary assumption, since the underlying
relation of inputs to outputs is independent of their valu-
ation. It is conceivable that all oroduction is unsaleable.

- 150 -

or destined to be given away, in which case there will be
expenses without revenue; even though the "matching" con-
cept is unserviceable here, we can still calculate a nega-
tive profit, or loss. The identification of stages in the
productxon process extends the possibilities of analysis
beyond the primitive ascertainment of profit, suggesting as
it does the functional areas in which profits and losses
may occur.

It goes without saying that the capital of the firm
is increased by the full value of the sale, and not by the
profit element included in this value, and that the cost
element restores that part of the capital which was consumed
or "used up" in the production process. Conventional fi-
nancial models of the firm ignore this observation, and this
is particularly noticeable iii the theory of corporation fi-
nance, where revenue as a source of capital is wholly dis-
regarded.

The Fvoduotion Process Acoounting Model of the Firm

The production process model of the firm is shown
in Figure 9 , where the manner in which it underlies the two
most frequently used accounting statements is revealed.
The contents of the first five columns compose the balance
sheet; of the last three, the income statement. The third
accounting statement, the funds flow, is a com.posite picture

- 151 -

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- 152 -

of the entire cycle; a cash flow statement would be a
summary of the third column, "Finance," and so on. The full
model applicable to a particular firm would need to be sup-
plemented by an image of the actual production cycle, as
shown in Figure 8 .

The history of the development of this model has
been explained in detail elsewhere^ ^ and it is suggested
that the use of accounting methodology for planning and
control must necessarily rely upon some complex view of
reality such as this one; we shall therefore call Figure 9
the accounting model of the firm, and assume that it can be
used to explain accounting and to predict the form which ac-
counting methodology will give to new phenomena not before
experienced. It is also a potential decision model, using
the techniques of sim.ulation, although marginal models can
be used in some situations where it is permissible to pro-
ceed by abstracting to a great extent from the complexity
of reality; such abstractions are the essence of operations
research models using linear programming methods. The de-
gree of abstraction permissible m.ust depend upon the nature
of the planning decision which is at issue. In the simplest
case, where only one or tv70 variables are affected, the
"see-through" model of decision theory may be efficient; in
a more complicated planning situation, it may well be de-
ceptive .

- 153 -

The accounting model is particularly eloquent on
the subject of valuation. It will be recalled that the
"see-through" model of the firm presented a straightforward
choice between entry and exit prices, and accounting the-
orists have argued the acceptance of both of these; the
cash flow and other models provided no assistance in solving
the valuation problem, either because they were presented
in a nonexistent physical form or because it was assumed
that value considerations were part of the behavioral pat-
tern of each individual decision-maker. The accounting
model shows that there is not one valuation problem but a
succession of these, since each stage of the production
process presents one; we must therefore contemplate the
simultaneous use of a variety of valuation models, rather
than the general acceptance of one ubiquitous method of
calculation. Although this observation is implicit in the
conventions of accountants, it is rarely made explicit, and
of the accounting theorists, only Mattessich has admitted
more than one valuation m.odel into his conceptual framework,
albeit in a less extensive form than the one adopted here.^^
The reason why theorists find it so hard to accept the co-
existence within a set of accounts of a wide variety of
valuation models is the implication of this view for the
mathematical decision models in which they are primarily -

-► 154 -

intere;^ted; the application of statistical method to
accounting data must remain at a fairly elementary level
until the data themselves can be demonstrated to have a
high order of homogeneity. This is, however, the least of
the problems involved, as V7e shall attempt to show in the
next section, where the essentially subjective nature of
all valuations v;ill be discussed.^**

What else can we say about the organization and
processes of the firm from a study of the accounting model?
The firm is linked with the outside world through markets :
the real estate market, the labor market, the raw materials
market, and so on. It is clear that there must be both a
capital market and a money market, and that any attempt to
analyze these markets as if they were one is doomed to
failure. Profits and losses can arise from dealings in any
of these markets, and although profit itself is a residual,
and as such not susceptible to analysis, the forces from
which it is derived can be identified and quantified for
purposes of prediction, planning and control. This adds a
necessary dimension to the concepts of "responsibility ac-
counting" and the "profit center," and constitutes a firm
bridge between organization theory and economics which
supplements the somewhat less secure behavioral assumption
upon which they both tend to rely.

- 155

Since markets actually exist between the organi-
zation and the outside world, information systems may be
devised to represent the relationships between them and,
given the present state of communications theory, it may
be useful to construct such systems in the form of com-
puter programs, or block diagrams. It would be more useful,
perhaps, to attempt to verify the assumption that the elec-
tronic processes of the computer are not only representative
of certain types of communication processes, but also nec-
essary elements in these processes; given the variety of
stimuli which affect human behavior, and its high degree
of unpredictability, this is not immediately apparent. We
can create a relatively unstructured image of a "total in-
formation system" as a set of information systems linking
actors with markets; we are unable to say, however, what
forms these systemis take, or specify their contents. It
is the absence of this knowledge which underlies the failure
of the "management information system." concept to produce
a workable model of the firm; accounting systems, on the
other hand, if they are structured to conform with known
operating systems within the firm, are relatively easy to
program and have been successfully transferred to computers
over the past fifteen years. ^^

The division of the processes of the firm into
stages in this way facilitates the measurement of any

- 156 -

physical flows between markets and the firm and within the
firm, but as we have repeatedly pointed out, there is no
value flow in a physical sense, so that this feature does
not help us on our way toward the development of appropriate
accounting valuation models by, for example, measuring flovjs
and calculating rates of flow. Where such a physical flow
is measurable we still are faced with a valuation problem
in much the same form as where it is not, except in those
relatively rare cases where there is a one-to-one corres-
pondence between the acquisition price and the physical
unit of flow.

The Accounting Model AppZ-ied to the Nonprofit Firm

Valuation and Government Revenue

If we define a firm as an organization of resources
for the purpose of production, and if we assume that the
objective of government is to produce goods and services
which individuals cannot or will not provide in any other
way, then government (and other nonprofit production units,
such as charities) can be analyzed by using the accounting
model of the firm. It is with a "formalized and abstract
description of the history of the firm" that Boulding claims
accounting to be conventionally associated, ^ ^ and while we .
would take issue with the emphasis on "history," we agree
with him that the concept of the firm should be extended

157 -

to include nonprofit units. We also agree that the
accountant is concerned only with those aspects of the or-
ganization and those processes of production which can be
valued; the underlying realities, which he calls "physical
quantities" but which we can conceive in more intangible
forms, are replaced by a quantity expressed in money as
the unit of account. The problem of valuation is common
to all forms of organization, and we must therefore ask:
in what way must the accounting model of the firm be adapted
for use in the analysis of nonprofit firms? We shall assume
that the government agency is representative of the problems
involved.

Government receipts from taxation are obviously not
revenue, since they are clearly attributable to the "cash
flow" or liquidity of the organization; we speak of govern-
ment revenue loosely to denote government ireceipts from all
sources, but it would appear that this term is being used
as a surrogate for the services which government is being
paid to provide. The final act of distribution,- the ren-
dering of a service which com.pletes the operating cycle,
cannot be defined in terms of sales revenue, but there is
clearly an exteriorization of services produced which takes
place when the government agency performs its economic pur-
pose; the question is v;hether the purpose can be defined in

- 158 -

such a way that the service rendered can be valued. If we
were to pose this question to a consumer, such as an indi-
vidual or a household, the answer would be that, in the
absence of an agreed scale of interpersonal utility compari-
sons, such a valuation would remain purely subjective and
have no relevance to any problems extending beyond the per-
sona of the individual or individuals concerned. In this
case, the only possible area of interpersonal agreement is
the valuation of cash transactions, since all interested
persons can satisfy themselves concerning quantities of
money received and paid; for this reason, governments rely
largely on cash accounting in the field of personal income
taxation, and attempts to extend the observations of the
income tax official to uses instead of acquisitions in-
variably prove counter-productive. Cash accounts are all
the accounting the consumer normally requires, although the
appearance of investment expenditures changes the picture.
Again, the extent to which the consumer can plan his con-
sumiption depends upon his ability to value, in money terms,
a diversity of satisfactions to be received at different
times, together with the related sacrifices; failing this,
he can still plan his acquisitions and disposals of goods
and services, but not their uses. The cash budget is the
appropriate mechanism for this limited objective, and cash
accounting the related control situation.

- 159 -

Government accounting has traditionally been
performed on the cash basis, modified to include p^irchases
and sales on credit, and attempts to adapt it to the ac-
counting model of the firm have been strenuously opposed.
The Taft Coroip.ission ' s re'^^ort of 1921 led to the introduction
of federal budgets, but its reconim.endations that budgeting
and £iCcounting should reflect economy and efficiency (i.e.,
should be concerned with use and not only with acquisition)
were not implemented by the legislature; the Treasury also
placed a narrow construction upon the Budget and Accounting
Act of 1921.^'^ The Hoover Commission of 1949 made similar
recommendations, leading to the introduction into govern-
ment of the concept of a "Planning-Program-Budgeting System"
(PPB) , and the Budget and Accounting Act of 19 50 directed
improvem.ents in government accounting for planning purposes.
Starting in 19 61 in the Defense Departm.ent, and with the
official backing of the President of the United States, by
19 69 only 26 of nearly two hundred agencies of t?ie federal
government had initiated inquiries into the system, and many
of these v/ere held back by procedural problems of valuation
and bookkeeping, known generally as the "crosswalk" problem
of reconciling the full accounting model with the rigid
rules for recognizing government expenditures heretofore
applied. A few had identified formal parts of the system

- 160 -

and incorporated them into the budget process by January,
1969. ■^^ A study of the work done by these agencies reveals
that it is largely an extention of the "cost/benefit analy-
sis" technique, which is statistical in nature and predicated
upon the assumptions of price theory which flow from the
concept of the individual consumer.

In national income accounting the government is
classified as a consumer, on the grounds that its expendi-
ture is a "final product," that is, represents acquisitions
of goods and services which are not resold. Preoccupation
with the phenomena of exchange is understandable in a pure
market economy, but the growth of the public sector in the
modern state renders market criteria inadequate. A large
part of the economic activity of the United States consists
of the production of services by the public sector, which
in 1969 accounted for some 35% of the gross national pro-
duct; in Western Europe the proportion is higher, having
reached 50% in the United Kingdom in 1968, and the commu-
nist countries display a similar characteristic. In the
light of this evidence, we find the assumption that the
government is a consumer to be in conflict with the facts,
quite apart from the moral and political overtones of such
a concept, which leads inexorably to the corporate state.
Kuznets has pointed out that many government services can

- 161 -

best be thought of as intermediate goods, in that they
contribute to output in the business sector, but this does
not go far enough, nor does his proposal to divide govern-
ment expenditure into two parts, consumption and investment,
answer our criticism. ^^ We agree that government investment
should be separated from government production of current
services, which is a normal by-product of applying the ac-
counting model of the firm to the processes of planning and
control .

We accept the proposition that the specific
objectives of government agencies are identifiable, which
is the form our assumption of rationality takes in this
context, even though we recognize the unv;illingness of
public servants to commit themselves in this way; an un-
willingness that no doubt finds its origins in their ex-
perience of the ingratitude of the people they serve. If
the objectives of a government service can be isolated,
then their valuation presents no greater problem than the
theater ov/ner faces in pricing admissions, or, more appro-
priately perhaps, than the manager faces in deciding how
much a corporation can afford to pay for subsidizing the
meals it serves in the works cafeteria.

The intellectual problem encountered is the
Aristotelean distinction between value in exchange and

162 -

value in use, and the attempt to resolve it by means of the
assumption that acquisition prices are objective evidence
of value. That the word "value" has two meanings was illus-
trated by Adam Smith with his celebrated "water and diamonds"
paradox; the obvious solution lies in finding a common fea-
ture in these two meanings, which Wicksell undertook to
do.^° Noting that value in exchange involved the concepts
of usefulness and saaraity , some economists had deduced
that utility governed demand and scarcity, supply; price
was a function of both, an observation which Wicksell found
too trite to warrant a place in economic science. The cost
of production theory of value depended upon exchange values,
and therefore could not be offered as an explanation for
them. Wicksell based his explanation on degrees of utility,
that is, he explained the phenomenon of exchange by refer-
ence to the fact that, for one party value in use was less
than the price, and for the other party more. But this did
not establish a meaning for "value in use"; merely a reason
for the profitability of exchange. Under the assumptions
of perfect competition it is legitimate to deduce that value
in exchange is evidence of value in use for the parties to
the exchange, and given the further assumptions of the
stationary state, that value in exchange is a constant
throughout the market and through time. In the absence of

- 163

perfect competition, however, economists are agreed that
actual prices are mere faits divers without normative sig-
nificance, and that the value in use which underlies value
in exchange is not thereby revealed. Whether value in use
will lead to a corresponding value in exchange is a sec-
ondary problem to us, although a primary problem to the
price theorist.

If it is accepted that the valuations which the
entrepreneur makes as a means of planning and controlling
the organization and processes of his firm are subjective
quantifications in money, d.ncluding the planning estimates
of selling prices which must, given roundabout production
methods, take place in advance of the exchanges from vrhich
alone objective price data could be derived, then it cannot
be held that the expression of government services in money
quantities is any different in kind. All that is required
is a validation procedure so that the subjective estimates
of civil servants can be rendered as objective as the sub-
jective estimates of corporate officials; this is what PPB
and cost/benefit analysis attem.pt to achieve. We are aiming
at Coleridge's "willing suspension of disbelief" rather than
Disney's "plausible impossible."

The resistance which is encountered to the valuation
of revenue in the absence of market sales arises from

- 164 -

certain fundamental logical errors in the theory of money,
which are so important in this context that we shall treat
them in a separate section.

The Nature of "Money" and "Valuation"

The function of money as a unit of account and of
a m.onetary scale as a measuring device are derived from the
same source as the functions of m^oney as a means of payment
and as an asset. To assume that these functions can only
be found together is the first of the logical errors re-
ferred to above .

We first observe that a good or service has exchange
value, and define a price as a quantitative representation
in money of exchange value. If the price expressed in money
is the desired measure of exchange value, in what way can
this property be separated from the good or service and
transferred from one person to another (as a book debt) or
stored (as an asset) ? In order for this operation to be
possible, money must have some abstract quality which is
distinct from the properties it possesses when considered
in relation to any one of its four functions. This abstract
quality must be distinguished from the "real" characteris-
tics of money as coins, bills, and so on, just as the numis-
matist must distinguish between coins which are legal tender
and coins v;hich are collectors' pieces. It is this abstract

- 165 -

quality, whether derived from custom or statute, which gives
money its power to mediate exchanges and serve as an asset,
and which also gives it a separate but related power to
measure values and serve as a unit of account.

The second logical error is to regard valuation
in money as a measurement of the same kind as, for example,
measurement in weight. In other words, we may not assume
that the propositions "X weighs 20 lbs." and "Y costs $20"
are structurally comparable. ^ ^ In the first case, we have
four elements; (1) X, the object being measured (2) lbs.,
the unit of measure (3) 20, the quantity and (4) weight,
the quality being measured. In the second case we have
only three of these elements: (1) the object, Y (2) the
unit, $ and (3) the quantity, 20. Where is the quality
being measured? The phrase "objective value in exchange"
reveals its emptiness, as does Chambers' invention "numer-
osity."

The proposition "Y costs $20" can never tell us
anything about properties of Y which can be perceived in
the absence of the price, as the weight of an object can
tell us about a quality we could perceive, albeit less
precisely, in the absence of such a measure. The proposition
means either "pay me $20 for Y" or else: "if I pay $20 I
will receive Y." The only meaning of such a proposition,.

- 166

in other words, is to be found in its usefulness to human
actors; of valuation in general we can say no more.

It is noteworthy that the papers given at a recent
seminar on research in accounting measurement made no men-
tion of this aspect of valuation; ^^ although Sprouse raised
the question of specifying the attribute to be measured/-^
for some reason this thought was not pursued, and all con-
tributors directed their attention to the object being
measured. Only Devine presented a treatment of measurement
which is compatible with the idea of valuation as. a sub-
jective quantification; in his view, all measurement is
fiat measurement, and the desire to assign numbers to mean-
ingful relationships need not be arbitrarily limited.^'*
The writers who have discussed the theory of measurement
in relation to accounting theory^ -^ have all taken as their
point of departure the interesting and influential views
of Stevens and Torgerson;^^ it must be remembered, however,
that these scientists were concerned with the application
of statistical method to observations of social behavior,
which is a problem of a lower order than the problem of
quantification which we approach through the concept of
value.

- 167 -

Conalusion

VJe have thus arrived at a conclusion v.'hich will no
doubt fail to satisfy those whose incipient ideal it is to
hand over the management of production to the computer, but
which the h^amanist will find reassuring. In order to iden-
tify a conceptual framework which will embrace all aspects
of accounting we have reconstructed the reality which un-
derlies the organization and processes of investment and
production, and found that it discloses a continuing need
to value if these processes are to be quantified in a form
suitable for planning and control. We have also found that
only in a minority of cases, where acquisition and use are
simultaneous, can the acquisition prices of the factors of
production be assumed to be the costs of production, and
that the planning function necessarily involves forecasting
future selling prices, the relevance to which of present
market prices is a question of fact in each case. Many of
the phenomena of use are divorced from acquisition of the
object being used in such a way that a subjective evaluation
is all that can be hoped for in this context, e.g., depre-
ciation of plant and equipment; provisions to make good at
some future date the current damage being perpetrated by
the elements; research and development. It is clear to
us that the element of expectations incorporated in even

- 168 -

the most conventionally prepared set of accounts is greater
than has been recognized by accounting theorists, and that
human cooperation hias been a more substantial factor in
progress using accounting statements than has technical
achievement. We find this conclusion pointing to a greater
role for accounting in the economic management of society,
since it liberates the theory of accounting from unnecessary
restrictions which have led many writers away from the broad
view of accounting as a planning and control methodology
and tov/ard a narrow view of accounting as business history.

NOTES

1. Maurice Friedman, "The Changing Image of Human Nature:
The Philosophical Aspect," American Journal of Psycho-
analysis, Vol. XXVI, No. 2 (1966), p. 141.

2. Ihid., p. 143.

3. Knight, Risk, Uncertainty and Profit (Harper Torch-
books, 1955) , p. 280.

4. Jbid.j pp. 317-18.

5. J. Marczewski, Planification et Croissance Economique
des Democraties Populaires (Paris: Presses Universi-
taires de France, 1956), Vol. 1, p. 303. (Our transl.)

6. E.g., J. A. Schumpeter, The Theory of Economic Develop-
ment (New York: Oxford University Press, 1S61) ,

pp. 62-3. (First pub. 1934.)

7. See Paul- Joseph Esquerre^ Accounting (New York: The
Ronald Press Co., 1927), p. 106 and Maurice E. Peloubet,
"Current Assets and the Going Concern," Journal of
Accountancy, Vol, XLVI (July, 1928), p. 19.

8. The modern three-period division of time corresponds
with our three situations of the firm. See p. 135.

9. Stephen Oilman, Accounting Concepts of Profit (New
York: The Ronald Press Co., 1939), pp. 110, 113, and
National Association of Accountants, Cash Flow Analysis
for Managerial Control, Research Report No. 38 (Nev;
York: N.A.A., 1961), p. 4.

10. Anson Herrick, "Current Assets and Liabilities,"

Journal of Accountancy, Vol. LXXVII (January, 1944),
pp. 48-55, and American Institute of Accountants,
Accounting Research Bulletin No. 30 (Nev7 York, 1947)
(Final edition, 1961.) The quotation is from Herrick,
p. 50, and the semantic problem recalls the GerTnan
struggle to distinguish between Gehrauchsgut and
Verbrcuchsgut .

- 169 -

- 170 -

11. John A. Higgins, "Responsibility Accounting," The
Arthur Andersen Chronicle^ Vol. XII, No. 2 (April,
1952) , pp. 1-17.

12. Marcel Morranen, Le Plan Comptable International,
Brussels, Eds. Cambel (1958) and Kenneth S. Most,
Uniform Cost Accounting (London: Gee and Co.
(Publishers), Ltd., 1961), Chs. 6 and 7.

13. R. Mattessich, Accounting and Analytical Methods
(Homewood: Richard D. Irwin, Inc., 1964), pp. 217-20.

14. Myrdal and Hagerstrom both argue that there are no
values in the objective sense, but only subjective
valuations which must be distinguished from per-
ceptions of reality. See Gunnar Myrdal, The Political
Element in the Development of Economic Theory (Harvard,
1955) , p. 13.

15. In a recent publication by the public accounting firm,
Haskins and Sells, the partner-in-charge of managem.ent
services for the fdrm, Mr. Gordon L. Murray, describes
the stages of evolution of the management information
systems for which he has been responsible since 1950.
It is clear from the illustrations reproduced that the
vital separation of the organization from the processes
has not been undertaken in constructing these systems,
although a subconscious striving to effect such a
separation is evident in the changes v;hich took place
between 1950 and 1970.

16. Kenneth E. Boulding, "Economics and Accounting: The
Uncongenial Twins," in W. T. Baxter and Sidney David-
son (eds.), Studies in Accounting Theory (Homewood:
Richard D. Irwin, Inc., 1962), pp. 44-55.

17. Arthur Smithies, The Budgetary Process in the United
States (New York: McGrav7-Kill , 1955), pp. 68-71.

18. Joint Economic Comm.ittee of the United States House of
Congress, The Analysis and Evaluation of Public
Expenditures: The PPB System, Vol. 2, Part IV, U. S.
Governir.ent Printing Office, 1969), p. 617.

19. S. Kuznets, National Income: A Summary of Findings
(New York: National Bureau of Economic Research,
1946) , pp. 131-33.

20. K. Wicksell, Lectures on Political Econom^y, Vol. I,
Part I, "The Theory of Value" (New York: The Macmillan
Co., 1934) , p. 18.

- 171 -

21. Gustav Adolf Gross, die wirtschaftstheoretisohe?!
'- Grundlagen dcs "Modernen KapitaZ-Csmus " von Somhapt

(Jena./' Verlag von Gusta Fischer, 1931), p. 142.

22. Researoh in Accounting Measurement , eds > Robert K.
Jaedicke, Yuji Ijiri and Osv/ald Nielson, Araerican
Accounting Association (1966).

Position and Income: Purpose and Procedure," ibid.j
pp. 101-14.

24. Carl Thomas Devine, "Some Conceptual Problems in
Accounting Measurements," ibid., pp. 13-26.

25. Mattessich; Chambers, Accounting , Evaluation and
Eoonorriic Behavioy? (New Jersey: Prentice Hall, Inc.,
1966); Thomas R. Prince, "An Overview of Conceptual
Measurement Issues in Financial Accounting Theory/'
in Theory Formulatioyis , Accounting Series No. 6,
Florida (1970).

26. S. S. Stevens, "On the Theory of Sca].es of Measurement,"
Science^ Vol. CIII (1946), pp. 677-80 and VJarren S.
Torgerson, Theory and Methods of Scaling (New York: John
Wiley and Sons, 1958).

CHAPTER VI
SOCIAL ACCOUNTING

If our hypothesis is correct, then the appearance
of an accounting system which embraces the activities of a
society as a whole will depend upon two factors:

1. The extent to which the society purposely sets
out to plan its economic future.

2. The extent to which the planners can agree on a
fairly detailed image of the realities of the
planned society.

The usefulness of such an accounting system will
depend upon the extent, to which the planners ' image con-
forms with the reality v;hich it purports to represent.

Social accounting is such an accounting system;
Yu v;ould prefer to call it macro-accounting, since he sees
important similarities between this and other forms of
accounting which suggest to him that the distinction be-
tween social and private accounting lies primarily in the
size of the economic unit studied. ■' "We use the term social
accounting ... to mean the whole system of accounts and
balance sheets of a nation or region, their price and
quantity components and the various consolidations that
can be derived from them."^ Although the term can be
criticized it appears to have acquired wide currency, and
we shall follow this current usage.

- 172 -

- 173

In this chapter we shall first examine the history
of social accounting in the context of national planning,
and the Soviet Russian and U. S. systems which represent
the two principal branches found in practice; this will
permit us to identify the image of economic reality which
underlies them and to show hov/ they may be modified to
conform with a more complex picture of a modern industrial
society.

History of Social Accounting

Early work in the measurement of national income
and wealth was predominantly statistical.^ First attempts
at "national income accounting,'' or providing estimates of
national economic aggregates through the m.edium of an ac-
counting model, were made in the 1920s in Soviet Russia;
a similar path was followed by the U, K. , the U. S. A. and
Canada after World War II, aided by a 194 4 conference on
procedures which clarified the terminology and m.ethods to
be used."* Many other countries have introduced social
accounting since those pioneering efforts established the
feasibility of this method.

Planning is a complex of actions v/hich involves
determining the goal to be attained, identifying the
necessary means and choosing among those means the ones
which appear to permit attaining the goal at the lowest

- 174

subjective evaluation of sacrifice. The plan itself must
arrange the employment of those means selected through time
and space in such a way that their complementarity is fully
exploited. Soviet planners first attempted to formalize
their plans purely in terms of physical quantities, but the
great failures of their early efforts directed attention to
the need for a financial plan, or national economic budget.
Only by translating the various operations contemplated by
the plan into monetary terms, and expressing the result in
the form of accounts, could the hierarchies of preferences
and scarcities and the possibilities of substitution between
goods and manufacturing processes be brought together in
order to evaluate them and produce an economic plan.^ In
Marczewski's view, the fact that important economic decisions
were made without such national accounts does not vitiate
this observation, since they consisted of choices between
a limited number of variables and variations, the full ef-
fects of which v;ere impossible to measure and compare.

Like the Soviet social accounts, the U. K. system
was first developed for planning purposes. The watershed
can be found in the period 1940-42; in 1940, Hicks published
an important paper distinguishing between the concepts of
national income at m.arket prices and at factor costs, but
which was clearly statistical in outlook,^ and in 1942 he
published the equally influential textbook The Social
Fz'amework^ which he had to be dissuaded from calling

- 175 -

"The Social Accounts,"^ In the inteirvening two-year period,
a collection of national income statistics such as the ones
provided by Colin Clark^ were transformed into a putative
accounting system; Harrod, in his biography of Keynes,
indicated exactly how thia took place. Keynes' book,
Bnw to pay for- the War-, created soiTie interest in the pos-
sibilities of planning the national economy more effectively
and led indirectly to the appointment of two economist-
statisticians, James Meade and Richard Stone, to the staff
of the U. K. Treasury, where Keynes was already installed
in a semiofficial capacity. These economists produced a
statement in account form which analyzed the U. K. national
income and expenditure in the v/inter of 1940-41, and the
following passage from the Harrod biography is particularly
interesting in the liglit of our comments on the valuation
problem in Chapter V of this study:

The Treasury had hitherto confined itself to figures
for actual, knov.'n transactions » This account included
estimates, and certain figures had to be obtained by
the method of difference from other estimates — all of
which was very dangerous. Yet this kind of national
income accounting has com.e to be regarded as the es-
sential tool of any economic planning, whether of an
individualist or socialist variety.

There appear to have been tv/o principal causes

leading to the adoption by non-Communist nations of an

accounting framework for their national income statistics.

The first cf these was a series of persuasive books and

papers, starting v.'ith Fisher's The Nature of Capital and

- 176 -

Income, asserting the relevance of accounting methodology
to the measurement of national income; these works created
an intellectual climate favorable to the task. The second
and proximate cause was the wartime condition under which
i^^civ^^ ciiii^ i^^v^j.*^ ,«^i.jvv_^, ,_ii^ gvj V ^^ n^ii^in^ iiciG rcquisitioneci a
large part of the U. K. economy, and the government budget,
in the form of an income and expenditure account, became a
major part of the total picture v.'hich national income sta-
tisticians were attempting to portray. The construction of
a similar tv;o-sided income and expenditure account for the
entire national economy was thus facilitated.^^ The ini-
tiative was follov/ed almost immediately by economists in
the U. S. A. , v;here the annual publication of social accounts
was started in 1947, the same year as the U. K.^^

Although the transition from statistics to accounting
can be demonstrated fairly clearly, the subsequent devel-
opment of systems of social accounts in the non-Communist
world cannot be attributed to national economic planning.
True, the stated objects of national income statisticians
include the formulation of economic policy, but few of the
countries concerned possess the legal and institutional
framework which would permit policies to be translated
into plans, and those which do, such as France, aim prin-
cipally at the planning of money flows rather than the
production of goods and services; the state influences the

- 177 -

choices of its subjects by increasing and decreasing their
coromand over the means of payment, and not by directives
allocating land, labor and capital to specific output ob-
jectives.

It has been suggested that the testing and
development of economic theory is an important objective
of national income statisticians, who are interested in
the production of quantitative data to be fitted into macro-
economic models, in particular . ^ "* This motive is clearly
apparent in the Hicks paper cited, ^^ where the money valu-
ation of the national income is considered. The particular
money values to be used, says Hicks, depend upon the purpose
for which the calculation of national income is to be used;
if social income is to serve as an index of welfare then it
should be valued at market prices "because jJ^'i-^'^s give us
some indication of marginal utilities," but if social income
is to serve as an index of production, then it should be
valued at factor costs. This distinction is only tenable
on the assumption, firmly made by public finance theorists
at that time, but less acceptable today, that indirect taxes
are passed on to consumers in the form, of prices (and that
corporation and other direct taxes are not) .

It can be seen from the Hicks paper that he had in .
miind the empirical testing of propositions in welfare theory
as a reason for obtaining a figure for social income at

- 17 3 -

market prices, thus extending the scope of Pigou's
contribution to this field. ^^ The empirical testing of
propositions in macro-economic theory, by providing quan-
titative data on aggregate demand, the consumption function,
the multipliei" and the marginal propensity to invest, and
by demonstrating the ex post equality of saving and in-
vestment, would also stimulate efforts to calculate national
income at market prices. National income at factor costs
would provide data for the development of a social pro-
duction function and for verifying theories of the effects
of changes in labor productivity on wage rates. As evidence
for the proposition that Richard Stone was also thinking on
these lines, v/e may note that he has said:

In attempting to give quantitative expression to
empirical constructs, such as the national income, it
is now generally recognized that a theoretical basis
is necessary and that this basis should be the conscious
concern of economists and not left in its practical
aspects exclusively tc business men, accountants and
the Comraissioners of Inland Revenue. Equally is it
clear that economic theory cannot be left at the
theoretical stage but requires to be tested and given
quantitative expression by being brought into relation
with observations. These lines of attack have resulted
in very considerable efforts to bring into being both
observations which are relevant to economic theories,
and also economic theories, or formulations of theories,
which are capable of being brought into relation with
observations . ^ ''

The history of social accounting since World War II,

and particularly its development in the U. S. A. and the

U. K. , tends to support this hypothesis, albeit tenuously.

A great deal of work has been done to improve the quality

- 179 -

of the individual statistics collected, but the accounting
framework remains inchoate, as it was left by Stone and
the other pioneers.^® The disappearance of the business
sector from the U. S. national income accounts, which has
been criticized by Yu and Rosen, among others,^' is expli-
cable with reference to an economic theory which abstracts
from institutional factors: there are no theoretical con-
structs which call for quantification here. The main thrust
of government has been on the "Flow-of -funds" accounts,
presumably because the Federal Reserve System has accepted
some responsibility for planning and controlling money
flows. The interrelated social accounting systems of
France, Holland and Norway, countries which have established
forms of national economic planning, provide a sharp con-
trast to the U. S. and U. K. systems, which contain a vast
amount of statistical material but are composed of sets of
accounts leading "separate lives."

The Soviet System

In the Soviet system of social accounting, a
techno-economic production plan constitutes a budget in
real terms, on the basis of which the accounts themselves
are constructed. The main purpose of these accounts appears
to be aimed at adjusting money flows to correspond with the
real flows envisaged in the plan. There are three kinds
of account:

- 180 -

1. National product.

2. National income.

3. Flov; of funds.

The national product is defined in Marxist terms

as: C + V + M, where C is the constant capital (equipment
a a

and production materials) , V the variable capital (sub-
sistence requirements of labor) and M the surplus-value,
produced by the variable capital. National income is
defined as V + M. The national product account is divided
into investment (A) and consumption (B) as a preliminary
to controlling the distribution of income in money terms. ^^

In the Soviet system, as in any other, there is
no question of an equality between "surplus- value" and
"investment"; firms are not allowed to retain the whole
of theix- profits, or forced to rely on profits for their
investments. The greater part of profits is paid over to
the state, and firms receive subsidies for the acquisition
of equipment. The picture must, therefore, be completed
with the aid of a flow-of --funds account, which in this
context is primarily a cash account for the whole economy.
This cash account is a consolidated statement of the trans-
actions of the various organs of the State, state enterprises,
banks and other institutions, together with estimates for
the public.

- 181 -

The Soviet National Product Account''

— — 1

■ '• — '—- ~

^ : E^'^—

~— -^-'—

=— =.-i=ar-^.i=^-:^=-_-=.-.^— .-t=

Sector

Branch

Functions

Allocation

Use

Public

Manufac-
turing
Construc-

Inver.tiT^.ent
goods :

1. Equipn'.ent
industries

termediato

Coopera-

consumption:

tives

tion

2. Consuiaption

Depreciation

1. Fixed

good

(capital)

Small

Agriculture

capital

industries

consu;nption)

traders

Transpor-

2. Working

Reduction of

Capi tali •^-

tn+-inn of

capita]

working capital

tic firiMs

goods

e.g., rav; rr.ater-

ials inventory

Production
convnunica-
tions

Product! on
co:aii:ercial

B.
Consumption

goods :

Households

Collectives

Inventory

changes
Government

tional incoir^e*

Fixed capital
formation

services
Other

these are
allocated
to ->

reserves

V.'orking capital
forir^a tion

tangible
production

Pestaurants

and then
to -y

Increase in
stocks of
consunpLion
goods

Production
services of
■banks

Consumption

*V + M

The national incoRS account shows hov; the national product is distrib-
uted, in the form V + M.

The Soviet National Income Account' '

Real

Monetary

Con

sump>tion goods

Waq

es and social security (V)

Households

V7ages — tangible production

Collectives

Social security charges

a. Civil

IncoT^e of agricultural and

b. Military

craftsmen's cooperatives

II.

Inv

estment goods

II.

Eur

plus-value (M)

Productive fixed capital

Profits

Nonproductive fixed
capital

s. State enterprises
b. Agricultural and

Working capital

ciaftsr.'.S'n's cooperatives

c. Sniall traders

d. Capitalistic finns
Turnover taxes

- 182 -

Receipts and Payraents of the Soviet Union

2 3

Receipts

Recei pt s from ente r p x i s e s ,

state agenci~e's~and
coop eratives ,

1. Public sector wages
and cooperative
members ' incom.e

2. Receipts of com:nunal
units other than from
sales

3. Sales of agricultural
produce to state and
cooperatives
Pensions
Study bourses
Interest, insurance,
construction loans
Other

4.
5.
6.

Total Section A

B. Receipts f rom the sale of
goods and services to the
population .

1. Receipts from coramunal
sales

2. Receipts from crafts-
. - men's sales

Total Section B

Total A + B

(= reduction in money supply)

Payuients

P ayments to enterp ris e s ,
state agencies and

cooperatives .

1. Purchases of
from state e
prises and c
atives .

2. Payments for
ices :

a. Rent

b. Transpor

c . Other cu
services

d. Cinema,
and othe

e. Sanatori
day home

f. Other se

3. Taxes, insur
subscription

4 . Saving

Total Section

goods
nter-
ooper-

serv-

tation
rrent

theater
r shows
a, holi-
s, etc.
rvices
ance ,
s

Payments for purchases
of goods and services by
the population .

1. Purchases on the
communal market

2. Other purchases

Total Section B
Total A + B
(= increase in money supply)

- 183 -

Whereas the product account appears to be an attempt
to portray the process whereby real goods and services are
produced and the capital used up in the process is replaced,
the receipts and payments account shows the transactional
relations between the sectors of the economy. It is, there-
fore, more of a cash account than a funds statement.

The U. S. System

We shall regard the U. S. system of social accounts
as representative of the non-Communist world; it is not as
well articulated as some systems, but provides more statis-
tical detail than most.^** The division of the economy into
production and consiim.ption conflicts with the transactional
basis of primary sectorization, and is conceptually narrower
than the Soviet division into investment and consumption;
this may arise out of the reliance of Western economists on
marginal techniques of analysis. The assumption that
physical quantities of goods and services are the basic
measures, separable from the prices by which they must be
multiplied to arrive at values, is a first indication that
we shall find the same Ricardian model of the economy
underlying both the So\'iet and the U. S. system.s. Hicks
is explicit on this point: there are two problems involved
in the determ.ination of the national incom.e, the enumeration
of real goods and services and their evaluation in money. ^^

- 184 -

There is also an index nuiriber problem, which has been
studied at length by welfare economists . ^ ^

Unlike the Soviet system, the U. S. accounts fail
completely to come to grips with the physical quantities,
and start with monetary data concerning payments, which
are adjusted for accruals to make them correspond with
acquisitions and disposals. Consolidation of transactions
originating in the business sector, however, obliges the
accountant to accommodate data concerning uses , the most
important item being depreciation. The imputatio.ns of
interest in the business sector accounts and of rental
income in the personal sector accounts further aggravate
the duality of the construction of these accounts, v/hich
can be seen on a comparison v/ith the Soviet receipts and
payments account to deal essentially with acquisitions
rather than uses. This attempt to include nonmarket
phenomena obscures the money flows of the nation, so that
a quite separate Flow-of-funds (or "money flows") account
is produced by the Federal Reserve System. Identification
of this "flow" in the real world discloses the existence
of capital movements in addition to those differences in-
cluded in the essentially "current" income and product ac-
count; the net result of the Flow-of-funds account is to
equate saving and investment and to demonstrate the insti-
tutional structure of each of these classifications.

- 185 -

The Flow-of-funds statement is, therefore, comparable not
with the receipts and payments account of the Soviet
system but with the funds statement of the business enter-
prise. In the last analysis, the U. S. national accounts,
like the business accounts which they attempt to imitate,

in the detailed statistics of the Federal Reserve System,
and only the net increase or decrease of the money supply
is incorporated in the Flow-of-funds statement.

U. S. National Income and Product Account

=.i; : : — ^ .

Income

Product

Factor payments

Wages and salaries

Sales to

consumers

Rental income of persons

Sales to

government

Interest received

Sales to

abroad

Corporate and other

Sales to

investors

profits (including

Net change in inventories

Corporate profits taxes

Social security payments

Transfer payments

Depreciation (not a payment)

Indirect business taxes

Business and government

transfers

U. S. National Flov7-of -Funds Account

Current expenditures
Goods and services
Transfer payments

Capital expenditures

Financial investment

Current receipts

Income receipts
Transfer receipts

Increase in liabilities

NB. There is usually a balancing figure, due to a statis-
tical discrepancy.

- 186 -

The input-output tables which make up the third
principal component of the U. S. system of social accounts
are something of an oddity; they attempt to perform, in
money terms, the function which the Soviet national product
account performs in real terms. The assumption of an
identity between money flows and real flows is supported by
additional assumptions of constant input coefficients (as
compared with the Soviet practice of using calculated norms
as techno-economic coefficients) , a constant allocation of
inputs to outputs in multiproduct firms, and constant prices. ^^
The result is a set of tables which purports to quantify the
"flow" of resources interindustry, between the public and
private sectors, and between the U. S. and the rest of the
world, but which in fact represents a primitive attempt to
analyze complex economic phenomena using an inadequate con-
ceptual framework. In this it resembles the cost depart-
mentalization tables used in industry r particularly in the
late 19th century, v/hich led indirectly to irrational price
competition and ultimately to price-fixing agreements,
trusts and cartels. It seems unfortunate that the knowledge
accumulated by cost accountants and industrial engineers
during the past seventy years could not h.ave been tapped
before Leontief started his enormous undertaking,^^

Turning to the measurement of wealth: although the
earliest national statistical exercises were aimed at the

- 187 -

measurement of wealth, recent emphasis has been on
Fisherian "income flows." For this reason the U. S. does
not count a national balance sheet among its social accounts,
although unofficial attempts to construct one have been
made . ^ ^

The structure of a national system of social
accounts of the non-Communist type is shown in Figure 10,
which also reveals the extent to which the U. S. is in a
position to implement it in its entirety. The dotted lines
signify the elements and connections v;hich are as. yet in-
complete, and the diagram should be read in conjunction v/i th
the criticisms of the U. S. social accounting system which
this chapter contains. In the conceptual framework of
Chapter V, the diagram shows only the capital and revenue
"flows" and the cash "flow" would necessitate a separate
set of accounts linked to the right-hand boxes through
cash transactions. Flow accounts for other forms of
resources, including credit, would likewise call for
separate sets of accounts, linked to particular values as
they appear in balance sheets.

Sooiat Accounting Critioaltij Appraised

Both systems of social accounting are incomplete,
although their technical deficiencies could conceivably be
rectified as economic statisticians learn more about

- 188 -

CO
G
O

o
o

•H
O
O
CO

«M

S
0)
+J
CO

Cfl

I-l
to
a
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•H

+>
nt

OrH

V >

(13 o;

-H

O rH

g-H

■+J 0)

M 0)

1 0)

o >

X! >

(1) CD

•H (U

3 (1)

W M

S -H

W rH

- 189 -

accounting, or as accountants occupy themselves with
social accounting. What is more to the point, however,
is that both systems are conceptually defective, since
they proceed from certain beliefs about economic realities
which are scarcely tenable in a 20th century environment.
The Soviet social accounts are founded on Marxist econom.ic
theory,"" and a misreading of it, at that.^^ This not only
leads to the adoption of a "narrow" concept of income which
excludes many services ; it also precludes a rational ap-
proach to investment because of the inability to value the
services of capital which is inherent in Marxism. A
further feature of the Soviet economy which undermines the
effectiveness of the social accounts is the characteristic
directive system, v/ith planning effected primarily in
physical quantities and prices im.posed from the planning
level rather than agreed at the level of consumption, or
investment. The basic materials of Soviet social accounting
are money and physical resources, the balances de ressouroes
en nature as Marczewski calls them, lists of which are sub-
mitted to the political organs of the state for consumption
and investm.ent decisions. The confrontation between
ideology and reality takes place at the highest political
level, and the task of the planning branch of government
is to translate the wishes of the political organ into a
form capable of fulfillment. The prices which are used

- 190

in the social accounts enter into the planning process at
a comparatively late stage; they are "valuations," it is
true, but of a kind which differs fundamentally from the
agreed values of a free society originating in the sub-
jective considerations of a multitude of individuals.
There is no way of determining whether the contents of the
Soviet national product or income accounts are "true" or
"false"; only cash receipts and payments are capable of
objective verification.

If the society which the Soviet leaders are engaged
in planning were in fact susceptible to direction of this
kind, that is, if the people were v;illing to accept the
valuations made by the planning officials, then this
method of constructing social accounts would not be open
to criticism. The values would provide stimuli of a
quasi-physical nature, and the "body" politic would react
accordingly. But the Soviet people are not essentially
different from other people, and each individual is capable
of developing his own values; since there is no official
institutional framework within which these values can be
asserted, he must necessarily create an unofficial one.
The unofficial institutions which arise exert their pres-
sures against the organs of the state, and the resulting
compromise falls far from the planned parameters of the
national budget. The usefulness of the Soviet social

191 -

accounts appeai-s to lie more in the initiation of a debate

than in the resolution of a conflict arising out of the

fact that means are scarce relative to ends.

The U. S. system also fails to come to grips with

this problem since the relevant aspects of valuation are

purposely avoided.

Instead of seeking to build up a single total, such as
the national income, an investigation is first made of
the classification of accounting entities, of the types
of accounts that they keep and of the transactions into
which they enter. In this way, all the transacting
entities of an economic system are classified into
broad sectors such as productive enterprises, financial
intermediaries and final consumers, and a series of
accounts for each of these sectors is set up, in v/hich
the separate entries represent economically distinct
categories of transaction. Economic activity is
represented by money flows and related bookkeeping
transactions, actual or imputed, between accounts.
The national income and other similar aggregates are
obtained from the system by selecting and combining
the constituent entries m the accounts. ^^

It is not essential that a system of social accounts

should provide, at one and the same time, an accounting

analysis of the economy such as would aid the planning

process and also the economic aggregates required by

politicians and economic theorists, any more than the

measurement of income is a necessary feature of a business

accounting system. The French Comptes de la Nation differ

from the U. S. and most other non-Communist social accounts

in that they constitute a disaggregated set of interrelated

accounts; they do not show "gross national product" or

"national income" and there is no financial statement

- 192 -

as such which is designed to reveal the national income
or product, or capital formation. Indeed, the definitjons
of flows used by French macro-economists differ from those
of U. S. and U. K. macro-economists, and the aggregate
"grcsG dcmcctic product," for example, is obtainable froip.
the Comptes de la Nation v/here the aggregate "gross na.tional
product" is not.

The fundamental problem, as the welfare economists
have pointed out, is "Who shall value the national income?"
Income is a personal concept relating to consumption, wh.ether
present or anticipated future; it quantifies being "better
off," in Hicks' phrase, and must relate to an identifiable
individual who can be said to have changed his state in
this way. Profit, or business net income, is the result of
a substitution of revenues for costs, and must be xelaLed
to a stage in a process of production, v/hether called an
"entity" or a "profit center." Measurement, defined as
expressing the degree of difference in distinguishable
characteristics and bringing it into a certain relationship
with a set of numbers (in this context, a monetary scale),
is an observable social phenomenon in both cases. The
sooial income can only be regarded as a measurable fact
if we first "set up a theory from which income is derived
as a concept by postulation and then . . . associate this
concept with a certain set of primary facts. "^^ The social

- 193 -

accounts are believed to find their theoretical foundation
in Keynes' General Theory, but closer inspection v/ill
reveal that the model used is essentially the Walrasian
systeraatization of a closed economy, which was adapted by
Hicks and Hansen to cope v/ith some of Keynes' more man-
ageable criticisms of that system's lack of contemporary
realism.^"* On the other hand, the principal feature of
current v/ork in the field of welfare economics is the
meticulous demonstration of the inapplicability of neo-
classical price theory to the development of propositions
concerning human welfare; the virtual impossibility of
bringing such propositions beyond a point of banal
generality is the main product of these publications.^^
The transition from individual, or small group,
personal income to national, or social, income can be
made in at least tv70 ways. An individual dictator or an
oligarchy can impose his or their values upon a society,
so that the national income can be found from his or their
subjective preferences; we have indicated in our remarks
on the Soviet system that a modern economy is too complex
for this. Alternatively, we can appoint specialists to
carry out this task on behalf of the population as a whole,
as we delegate so many of the important tasks of our
society to committees of experts. These men would have
to be experts in valuation, however, not in statistics;

194 -

they would need to be chosen from the ranks of those whose
rationality was buttressed by a knowledge of men and af-
fairs. In the last analysis, the measurement of the
national income turns out to be a political action, as
the measurement of business income turned out to be a
business judgment; on no account can it be a purely sta-
tistical exercise based upon the summation and consolidation
of money flows.

To this the national income accountant may reply
that his aggregates, while derived from money flows, are
surrogates for the "real" income and product which we would
prefer to know, but fail to grasp. The use of the word
"real" here is the source of much difficulty, because of
a duality of interpretation of the manner in which it is
contrasted with "m.onetary." The adjustment of money values
by means of a price index so as to express them in terms
of a common base can never improve the usefulness of
national income statistics beyond making them more com-
parable; it is a pure smoothing exercise, and any defi-
ciencies of the initial observations are transferred intact
to the adjusted figures. This version of "real" national
income, i.e., current national income adjusted by means
of a price level index ^ is different from the concept of
"real" national income as the goods and services which,
measured in physical quantities, are to be multiplied by

c, ^ _

- 15 5

prices in arriving at an index of welfare, or production.
It is this latter concept for which money national income
is to serve as a surrogate.

If monetary measurements of national income are to
be used in this way, then the implications of our hypothesis
are that separate systems of accounts must be set up for
investment (including production) and for consumption,
since the bases of valuation adopted in the two areas of
human activity are fundamentally distinct. Whereas money
as a medium of exchange and as an asset takes precedence
over its other functions in the consumption area, in the
investment area we are interested in money as a unit of
account and as a measure of value. Once this is accepted,
then it becomes unnecessary to answer the question: "Who
shall value the social income?" for the social income be-
comes a simple aggregate of payments. The valuation
problem relates solely to the national product; the monetary
transactions v;hich constitute the national income, and which
are a function of the national product together with inter-
personal money transfers, present virtually no separate
valuation problems to confuse the analyst who is concerned
with developing models for planning and control.

We must distinguish clearly between our two
conceptually distinct but transactionally related areas
of accounting for investment and consumption. The national

- 196

product is defined as a representation in money of the
social output of goods and services for a given period,
divided into consumption and investment goods and services.
The valuation of these objects is a critical problem,
depending as it does upon expectations and other subjective
considerations at. the time of investment, and the possi-
bility that these may change during the period of production.
The national income is defined as an aggregate of the means
of payment made available to the population in a given
period, derived from the sources designated "factor shares"
in distribution theory, and which may be used for consumption
or financial investment (saving) . The preparation of a
national product account calls for an im.age of the organi-
zation and processes of production of a society; with this,
the analysis can be assimilated to that of the individual
production unit. This is shown in the matrix of Figure 11,
where the colum.ns are those of Figure 9, extended to include
transfers of the proceeds of distribution (e.g., dividends,
donations, subsidies and subventions) and the rows represent
a tolerably realistic sumjnary of the many facets of a modern
economy; the rest of the world sector is included to con-
vert the model into a closed system."^

The national income account would show the factor
and transfer payments on the right-hand side and acquisi-
tions of goods and services from, investment sources on the

- 197 -

in 4J

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- 198 -

left; the retained earnings of corporations would not be
included with the former, or sales of investment goods
(or inventory changes) with the latter. The difference
between incomes and acquisitions constitutes saving,
which can thus fail to equal investment ex post; this
would convert the national accounts from an identity to
a set of behavioral equations and provide the analyst with
an invaluable tool for planning and control decisions.
We suspect that many of the false problems which have
preoccupied national income statisticians would also
disappear, such as: how to account for "investment" in
consumer durables; what happens to the national "incom.e"
v/hen the economist marries his housekeeper; or whether the
national income can be truly said to have increased because
a rocket launch at Cape Kennedy had to be aborted.'''''

Conclusion

The statement that the social accounts of the
non-Communist countries are conceptually deficient, because
they have been constructed on the basis of a Ricardian
image of a preindustri al society, implies that their use-
fulness is highly suspect, quite apart from any v/eaknesses
to which the data may testify and which arise out of sta-
tistical problems of collection and presentation."® Recent
work of the United Nations on its system of national

- 199 -

accounts, which demonstrates both the articulation of the

full system and its representation in matrix form, still

fails to distinguish between investment and money flows,

which are combined in the various accounts in a manner

wholly at variance with economic realities. ^^ We have

put forward suggestions for fundamental changes which we

regard as necessary for the modernization of the system,

and an econom.ic theorist may well object to so radical an

approach on the grounds that the existing system is based

upon a well-understood conceptual framev/ork which, while

incomplete, is nevertheless better than nothing. If the

constituents of these theories can find their counterparts

in the social accounts, then the latter can be used for

testing and refining the theories. To this V7e can only

reply by quoting from the seminal report of 1947:

In so far as the entries in the working system fall
short of some theoretical ideal, either because a
compromise has been made for lack of data or because
the ideal is not expressible in terms of operations
which permit of measurement, they will be misleading
if they are used for purposes other than those for
which they have been constructed. It is thus important
to examine the definitions employed in order to see the
limitations on the legitimate use of the system. Thus,
for example, the concepts of consumer's expenditure
and capital formation which seem appropriate from the
point of view of distinguishing between the two prin-
cipal components of the national product do not neces-
sarily coincide with consum.ption and additions to
wealth and such differences must be made explicit. "*"

Our proposal to separate product "flows" from

income "flows" would make necessary the preparation of

- 200 -

national balance sheets and wealth statements, since the
dynamic elements of the former can only be considered in
relation to changes in the states disclosed by the latter.
It would be unwise to underestimate the difficulty of this
task in the light of studies which have already been made
in this area,**^ although a regionalization of the task
would undoubtedly help to render it more manageable. We
may point out that our separation effects a massive sim-
plification, since capital goods fall to be valued only in
the investment accounts, and the balance sheet items of the
consumption accounts are limited to financial assets and
liabilities. On these items, as on the constituents of
the proposed Social Product Account, data are readily
available, although they could obviously be improved con-
siderably.

We are prepared to acknowledge a limited usefulness
of the social accounts prepared by free economies at the
present time; there is the overriding necessity to experi-
ment in this field, which transcends quality judgments, and
there is a demonstrated use in international negotiations,
as, for example, in determining appropriate contributions
to the United Nations, NATO and other paranational organi-
zations. International comparisons of income, wealth and
v/elfare are another matter entirely; one need only consider
the case of the U.S.A. whose national income and gross

- 201

national product appear to have doubled during a period
when its urban societies have all but collapsed, its
public services have been demonstrably inadequate to cope
with the needs of the population, and enormous money incomes
have been made available to individual and corporate land-
owners to induce them not to produce goods which are
nevertheless scarce in relation to individual needs.
We submit that our suggested schem.e would throv; some light
on the nature of the problem posed by these anomalies, since
it would be possible to demonstrate, if such were the case,
that money incomes of $900 billions had been made available
at a time when the social product had a value of, say,
$500 billions. The implications of such information for
the attack on inflation are obvious. VJhether the infor-
mation can be regarded as useful, however, is in the last
analysis, a philosophical question; if we believe that all
planning of a social nature is contrary to the interests
of the individual, then social accounting is clearly an
exercise of exquisite futility. We prefer to take a
position somev/hat more favorable to the endeavor, by
stating that a limited amiount of planning has proved
possible even in a free society, and that the potential
benefits of such planning can be determined only by
experiment and the evaluation of evidence.

NOTES

1. S. C. Yu, "An Appraisal of Macroaccounting, " in
Aspects of Contemporary AGCounting (Florida, 1966),
p. 25.

2. M. Gilbert and Richard Stone, "Recent Developments in-
National Income and Social Accounting," Aaaounting
Research^ Vol. 5 (1954), p. 2.

3. Paul Studenski, The Inaome of Nations (New York,
1958) , Chs. 2-10.

4. Edward F. Denison, "Report on Tripartite Discussions
of National Income Measurement," Studies in Inaome
and Wealth, Vol. 10, Conference on Research in
Income and Wealth (New York: National Bureau of
Econom.ic Research, 1947) .

5. J. Marczewski , Planifiaation et Croissanoe Eoonomique
des Demoaraties Populaires , Vol. 1 (Paris: Presses
Universitaires de France, 1956), p. 155.

6. J. R. Hicks, "The Valuation of the Social Income,"
London, E'^onomiaa, Vol. VII, No. 26 (1940), pp. 105-
24.

7. First English edition, Oxford (1942).

8. Personal communication from the author.

9. C. G. Clark, National Income and Outlay (London:
Macmilian and Company, 1937) .

10. R. F. Harrod, Life of John Maynard Keynes (New York:
Harcourt, Brace, 1951), pp. 497-503.

11. Ibid., p. 498.

12. Studenski, p. 153.

13. See Gerhard Colm, "Experiences in the use of Social
Accounting in Public Policy in the United States,"
Inaome and Wealth, Series I, International Association
for Research in Income and Wealth (Cambridge, 19 51) .

- 202 -

- 203

14. M. Yanovsky, Social Accounting Systems (Chicago:
A3.dine Publishing Co., 1965), pp. 12, 216; and
Jean Meyers Comptahilite d ' Entreprise et
Comptabilite. Nationale (Paris: Dunod , 1969),

p. 11.

15. "The Valuation of the Social Income."

16. A. C. Pigou, The Economics of Welfare (London:
Macmillan and Company, 1920).

17. Richard Stone, The Role of Measurement in Economics
(Cambridge, England,- 1951), p. 3.

18. See, for example, "The National Income and Product
Accounts of the U. S.: Revised Estimates, 1929-64,"
Survey of Current Business (August, 1965), p. 6.

19. Sam Rosen, National Income (Ne\\' York: Holt, Rinehart
and Winston, 19 63) .

20. Marczewski, p. 492.

21. Adapted from J. Marczev/ski, "The role of national
income accounts in the planned economies of the
Soviet system," Income and. Healthy Series IV,
Phyllis Deane (ed.) (London: Bowes & Bowes, 1955).

22. Ihid.

23. Ihid.

24. Yanovsky, op. cit . , Ch. II; and The National Economic
Accounts of the U. S. A.: Review ^ Appraisal and
Recommendations , National Bureau of Economic Research,
General Series 64 (1958), p. 28.

25. Hicks, "The Valuation of the Social Income," p. 105.

26. I. M. D. Little, A Critique of Welfare Economics ,

(2d ed.; Oxford, 1957), Ch. XII; and J. de V. Graaff,
Theoretical Welfare Economics (Cambridge, Massachusetts,
1957) , Ch. XI.

27. See Hollis B. Chenery and Paul G. Clark, Interindustry
Analysis (New York: John Wiley and Sons, Inc., 1959),
pp. 157-78.

204 -

28. Wassily Leontief, The Structure of the Ameviaan
Eooncmy^ 1919-29 (rev. ed.; New York: Oxford
University Press, 1951).

29. Raymond Goldsmith, A Study of Saving in the U. S.
(Princeton, 1956), Vol. 3, Part 1.

30. Studenski, p. 352.

31. Ibid. J pp. 22-3; and Michael Kaser, "A Survey of the
National Accounts of Eastern Europe," in Income and
Wealthy Series IX, ed. Phyllis Deane (London: Bowes
and Bowes, 1961), pp. 143-144.

32. Measurement of National Income and the Construction
of Social Accounts 3 Report of the Subcommittee on
National Income Statistics of the League of Nations
Committee of Statistical Experts, United Nations

(1947), p. 7.

33. Richard Stone, Measurement in Economics ^ p. 9.

34. The Geyieral Theory is sufficiently obscure in places
to be quoted, like the Scriptures, for a variety of
purposes. VJe claim its support for our attempt to
bring investment into the center of accounting theory,
as Keynes attempted to direct attention to the impor-
tance of investment in economic theory. The particular
point at issue appears from a study of J. R. Hicks,
"Mr. Keynes and the Classics," Econometrioa^ New
Series, Vol. 5 (April, 1937), pp. 147-59; and Alvin
Hansen, A Guide to Keynes (New York: McGraw-Hill,
1953) , pp. 3-35.

35. Little; Graaff; William J. Baumol, Welfare Economics
and the Theory of the State (London, 1952) .

36. E. Fuerth attempted someting on these lines in "A
Flow Chart for Social Accountants," Accounting Re-
search, Vol. 4 (1953), pp. 214-238, but without
sectorization; he did not bring out the dependence
of income upon investment.

37. See Measurement of National Income and the Construction
of Social Accounts 3 Chs. II-IV, and similar official
publications .

38. See Oscar Morgenstern, On the Accuracy of Economic
Observations (1st ed,; Princeton, 1950), Section IV.

- 205 -

39. A System of National Aacounts (New York: United
Nations, 1968), espec. Chs. II and III.

40. Measurement of National Income and the Construction
of Social Accounts ^ p. 25.

41. R. W. Goldsmith and R. E. Lipsey, Studies in the
National Balance Sheet of the U. S., National Bureau
of Economic Research (Princeton, 1963) ; and Pleasuring
the Nation's Wealth, Vol. 23, Studies in Income and
Wealth, National Bureau of Economic Research, Washing-
ton (1964).

CHAPTER VII
THE FRENCH ACCOUNTING EXPERIMENT

France presents us with a well-documented example
of the use of accounting for economic development. As with
any social, experiment, it is impossible to associate cause
and effect so as to support a conclusion that the French
accounting experiment contributed to the economic recovery
of that country after World War II; ve can only point to
the fact that there has been, and still is, a widely-held
belief on the part of competent French officials that ac-
counting does have a significant part to play in the
economic development of the modern state.

In Chapter I we drew attention to the fact that
the French economy had been devastated by war, and that
its first postwar government, faced with the task of
stimulating a rapid recovery to something like the prewar
level of social output, decided on measures aimed at
creating a strong accounting profession. It may be asked
why, in a country versed in the arts, sciences and tech-
nology, whose people had made notable contributions to
accounting theory and practice during the 19th century,
it was necessary for government intervention for this
purpose. The answer to this question is to be found in

- 206 -

- 207 -

the observation that, by the 1930s, accounting had become
dominated by the law; not only was the French accountant
engaged largely in satisfying the requirements of the
country's company and tax laws, but his professional ac-
tivities were as closely regulated as those of the other
professions in France, and accounting was taught in law
schools rather than in faculties of economics or business
administration.

The civil servants to whom was entrusted the
postwar reconstruction appear to have appreciated the need
to use accountants for planning and control, rather than
for the passive description of juridical observations.
They introduced special legislation in order to create an
organ of state which would be an alternative source of
influence over the accounting profession. The aim of this
agency was to foster the study of relationships between
the firm and its environment, and between the various
disciplines which contribute techniques to the management
of investm.ent and production, and which use accounts as
an analytical method.

History and Organization

The French commercial code and the company lav/s
of 1867 were the principal sources of accounting regulations
prior to World War II. In 1945, the Ministry of Finances

208 -

and Economic Affairs set up a Comraittee for the
Rationalization of Accounting, v/hose task was to propose
a national uniform system of accounts and to make recom-
mendations for its application and utilization for the
benefit of the national economy. The first national chart
of accounts, or Plan oomptable qSti Si'' a I, appeared in 1947,^
and in the same year the Committee v/as replaced by the
Conseil Superieuve de la Comptabilite , charged with super-
vising the introduction of the Plan. In 19 57 the name of
this body was changed to Conseil National de la Comptabilite .
The chart was to be applied in all state agencies of an
industrial or commercial type, of which nationalization
had created a good number, and in "mixed" enterprises,
those firms in which both public and private interests
participated. The chart was accompanied by a model balance
sheet and profit and loss account, together with detailed
instructions for the operation of the accounting system and
the preparation of period financial statements.

The Plan of 1947 appeared at a time when dirigisme ,
or direction from above, was the dominant influence on
French politics, and its authors envisaged the eventual
compulsory application of the national chart of accounts
to all public and private enterprises in France. A series
of ministerial orders applied the chart, with modifications
of detail in each case, to government agencies, public

209

enterprises and firms operating with state backing, or
subject to state control. The last situation could arise
through the acknov;ledged interest of a broad section of
the population (e.g., the agricultural cooperatives), or
because the finus in "uestion had received substantial
fiscal benefits through revaluation of assets. After ten
years' experience with the chart it was found advisable to
make its application voluntary in most of the private sector,
and a revised version of the Plan was introduced by minis-
terial order dated May 11, 19 57.^ This is a volume of some
250 pages, including a detaiJ.ed chart of accounts, sup-
porting the summary chart we have reproduced in translation
on p. 210 f together with a series of model financial and
statistical reports. It also contains the texts of the
ministerial orders mentioned above, a manual of operatirig
instructions, some definitions of technical terms, and a
variety of ideas on financial and accounting problems. A
second revision is in progress at the time of writing this
study.

The Conseil , v/hich is responsible for these
initiatives, has been assigned the following goals:

1. Coordination and synthesis of theoretical and
technical research in accounting, together with
practical applications.

2. In cooperation with other interested parties:

- 210 -

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- 211 -

a. To centralize knowledge, initiate studies
and disseminate information on the teaching
of accounting in schools and colleges.

b. To advise on accounting regulations or
recommendations before any promulgations by
government agencies, public comniissions , or
committees controlled directly or indirectly
by the State.

c. To propose any measures relating to the rational
use of accounts by firms, or in the form of
public budgets or social accounts.

3. Developm.ent and adaptation of the Plan aom-ptabte
geneval . ^

The interdisciplinary character of the Conseil has
been purposely achieved in order to combine representatives
from the law, economics, business administration, statistics,
scientific management and the accounting profession for the
attainm.ent of these objectives. The president of the
Conseil is a senior civil servant, and there are five
vice-presidents representing, respectively, the Ministry,
government accounting, the leading professional institute
of accountants {I'Ovdre des experts aomptabZes et oomptabtes
agrees), business firms and higher education. In addition,
the Ccnseil comprises representatives of those institutions
which have accounting as their object (schools of account-
ancy, publishers of accounting and ancillary works, auditors
of public enterprises, etc.), other accountancy societies,
organizations of chief accountants and industrial engineers,
trade unions and employers' associations, together with
civil servants selected because of their accounting

- 212 -

experience and other persons chosen for their knowledge of
the law, economics and finance.

The Conseil meets in plenary session to define its
policies and to draw up its program. The detailed work is
delegated to Seations , whose activities are coordinated by
an administrative department under seven rapporteurs
(discussants). The sections cover:

Section 1,

Section 2

Section 3.
Section 4 ,

Section 5 ,

Section 6 .

Section 7.

Documentation, public relations,
dissemination of information.
Studies relating to the professional
education of accountants, and courses
in schools and colleges.
General problems arising out of the
application of the Plan.

Principles and techniques of financial
accounting. Rules for drawing up a
balance sheet, profit and loss account
and appropriation account, particularly
in relation to public enterprises and
"mixed" firms, where the procedures
are complicated by legal considerations.

Managerial and cost accounting.

Agricultural accounting, including
agricultural cooperatives »

Government accounting and accounting
for government agencies.

Social accounting.

Relations between business, government

and social accounts.

Efficient accounting methods.
Budgeting and business planning.
Statistics for management.
Accounting equipment.

- 213

The Period 1947-62

A decree of 1962 (No. 62-470) revised the conditions
under which the application of the Plan was to proceed, and
called for progress reports, the first of which was pub-
lished in 1963.'* The report noted that the Plan had been
adopted by virtually all public enterprises (coal, elec-
tricity, gas, air and rail transportation, etc.) and by a
large proportion of the "mixed" firms. While' it was more
difficult to draw firm conclusions concerning its application
in the private sector, progress was satisfactory for a number
of reasons:

1. Fiscal lav;s had favorized the Plan's adoption.

2. Teachers had taught the form and contents of the
Plan to many who were now practicing accountants.

3. The intrinsic qualities of the Plan had recommended
it to many firms as both practical and convenient.

The benefits which flowed from, the adoption of the
Plan were given as: an established terminology which
elim.inated ambiguities; precise and logical rules for
classification and analysis; principles aiding the deter-
mination of values; a common language facilitating communi-
cation between the manager and the accountant. These
benefits were largely restricted to the area of financial
accounting, and experience had revealed the need for sub-
stantial research on an industry basis in order to estab-
lish norms in the area of cost accountina. This was

- 214 -

one of the reasons underlying the 1957 revision, which had
replaced the obligatory cost accounting provisions of the
1947 Plan with more flexible rules which gave firms vir-
tually complete freedom in this area.

The new Plan modified the previous one by
suppressing all regulations which called for sanctions in
the event of noncompliance, and replacing instructions by
recommendations throughout. It also laid down the rule that
all parts of the Plan dealing with bookkeeping methods and
records were to be regarded as recommendations for financial
accounting only; even those undertakings which were under
statutory obligation to apply the chart were granted vir-
tually complete freedom as to the form and content of their
cost accounts.

This change in policy is all the more remarkable
when it is recalled that one of the factors which led to the
introduction of the original Plan V7as widespread tax evasion
through the falsification of accounts. The explanation lies
not only in the swing to the right which French politics
experienced during this period, but also in the great
measure of support which the first Plan received from com-
merce and industry, and its v;ide voluntary acceptance.
For example, over 45,000 copies of the first Plan were
sold to the public, and also large number of textbooks by
individual writers which undertook its exposition.^

- 215 -

Nevertheless, it was acknowledged that:

a minimum of accounting discipline may be imposed v/here
businesses call for financial aid from the State, or
tender for its business.^

It is also interesting to note the disappearance
of the phrase "gross profit" from the model profit and loss
account. The authors of the Plan stated:

Many accounting practitioners will doubtless regret
that the account does not reveal a gross profit. This
point has been the subject of great argument. It has
appeared that opinions differ seriously concerning the
meaning of this expression, and that it would not be
possible to use the gross profit as a basis for cal-
culating 'break-even' points unless all so-ca.lled
'variable* expenses were deducted from sales, irre-
spective of their type or function (purchasing, pro-
duction, distribution, administration).''

trogvess Si-noe 19 6 2

A major result of the 1962 decree was the
establishment of professional committees for industries,
with the objective of producing uniform accounting systems
compatible with the Plan for each industrial grouping.
Such systems would, it was expected, lead to the adoption
of charts of accounts which, while basically homogeneous
with the Plan, could reflect the particular features of
the industry concerned; at the same time, solutions adopted
by one industry to problem.s experienced also by others
would be analogous and consistent. Thus, for example, the
definition of "purchases" in one industry should correspond
with the definition of "sales" in the industry from which
they are bought.

- 216 -

Guidelines were laid down for these committees
by a special subcommittee of the Conseil, composed of the
ra-p-porteurs des sections and representatives of the employers'
associations and government agencies involved, together with
professional accountants. First priority was given to propo-
sitions concerning financial accounting, but in the light of
the significance of the cost accounts for certain elements
of the financial accounts, the study of cost accounting
should be undertaken before the completion of work on
financial accounting. For its studies of financial ac-
counting, the professional coramittee should be constituted
on the widest possible basis, because of the influence of
size on the problems posed by this area. The study of cost
accounting problems should be delegated to persons familiar
with managerial uses of accounting information, and this
work would be coordinated by the professional committee,
and not by the Conseil. Finally, the taxonomic problem
was resolved pragm.atically : the optimum level in the
pyramid of industrial structures should be the highest
level at which uniform accounting could be achieved
rapidly. All attempts to classify a priori were, there-
fore abandoned in advance, and replaced by a preliminary
study of the possibilities of the situation, vide
Mary Parker Follett.

- 217 -

An initiative tending to inform accountants and
industrial organizations of the plans being laid was the
circulation of a paper outlining the objectives of the
Conseil and of the measures being taken to constitute
professional comi-nittees . It was known that some work was
already being done in a few industries at different levels,
so that it was decided to establish contact with them as
representative industries: metal-working, heavy electrical,
textiles, chemicals. By July, 1953, the following classi-
fication had been adopted, and most of these industries had
submitted adaptations of the Plan for approval by 196 6 at
the latest.

Vowev. (Coal, electricity, gas, atomic energy, certain
domestic oil companies.) It was found advisable to set up
separate professional comiriittees for oil research and
exploration (production of hydrocarbons) and for refining
and distributing.

Building aonstruation . It was found advisable to set up
separate comjnittees for public works and other building
construction, the latter to pay particular attention to
the needs of small firms of craftsmen. In the event, a
joint Vlan was adopted.

Building materials . Because of the complexity of this
industry, no progress was reported through 1965.®

Metal-h.wrking , The close ties between the metallurgical,
mechanical and electrical industries rendered the task of
classification complicated.

a. Iron and steel — the committee's work was delayed
by problems in valuing fixed assets.

b. Mechanical and metal-working —

- 218

1. First transformation of steel, and iron-founding.

2. Non-ferrous metals (except for bauxite, the bulk
. of these are imported) .

3. Fabrication.

4. Automobiles and cycles.

5. Other mechanical and metal-working.

c. Electrical — ^heavy electrical and electronics.

Chemiaats .

Textiles. A basic problem arose through the fact that the
historic organization of the industry is on the basis of
the materials used, whereas technology is now of prime
importance. It would have been preferable to classify the
industry into spinning, weaving, knitting and so on, but
in the event it was decided to form two committees, one for
those industries which start with the raw material, and one
for those which transform the products of the first. These
also produced a joint Plan.

Pvinting and graphic arts.

Wood-working .

Leather and furs. Separate Flans adopted for tanneries and
for shoemakers .

Transportation. No initiatives v/ere reported in respect of
maritime transport, although two of the largest French firms
had adopted the Plan in its original form; difficulties were
experienced with inland water transportation, which was
operated largely by the public sector. Read transportation
was likewise difficult to organize.

Banks and insurance . These were already subject to legal
regulations prescribing the form and content of their ac-
counts, v/hich antedated the first Plan, and it is ironic
that the greatest obstacles in the way of the adoption of
the Plan lay in the fields of credit and finance.

Food. The retail butchers were among the first to adapt
the Plan for their use. Other branches were: wholesale
grocery, perishable foodstuffs, multiple retail stores.

- 219 -

Adaptations were foreseen for the clothing, pharmaceutical,
paper and boxinaking and furniture industries, and proposals
were under consideration for agriculture, forestry, various
branches of food manufacture, ship and aircraft manufacture,
defense contractors, rubber goods, rental housing and apart-
ments, hospitals, and a variety of other trades and in-
dustries. ^

Tke PsychoZogioal and Techn-icat Problems

Psyohological Problems

Although in general favorable, reactions to the work
of the Conseil have been unfavorably influenced by certain
factors, notably fear of the way in which government might
make use of information obtained as a result of the work of
the professional committees. Fear of fiscal consequences
is the most commonly expressed, in particular, of the pos-
sible outcome of a situation in which the tax laws and the
prescriptions of the Plan conflict. For its part, the
Conseil has expressed to the Minister the view that no
fiscal regulation should affect either the terminology and
rules of the Plan, or the normal methods of keeping accounts,
and whatever the advantages of fiscal measures imply j.ng a
divergence between the tax laws and accounting norms, these
advantages should be obtained in the form of measures af-
fecting assessment to tax and not in the form of modifications
of the process of profit determination.

Representatives of those industries to which
government is an important customer also experienced some

- 220 -

hesitancy in providing information which might be useful
for the regulation of their markets, particularly when the
committees proceeded to discuss cost accounting. They re-
quired to know in advance what rights the Ministry would
acquire for investigating their cost accounts during the
course of negotiations, in contract determination, and in
post-audit. The Conseil was only able to assure the parties
that its interventions were designed to facilitate the
resolution of disputes which might arise from problems of
accounting, a frequent occurrence in this area. It is
obvious that the regulation of such markets would be
greatly helped by uniform cost accounting, as recent
developments in the U.S.A. bear witness,^" but it is
equally clear that, in order to pursue its objectives of
improving the quality and flov; of accounting information
generally, the Ministry would seek to avoid conflict by
relying on the findings of the professional committee.
A difficulty might arise through a government agency
laying down definitions and rules before the relevant
adaptation of the Plan appeared, so that it would be
advisable to promulgate such regulations as temporary
guidelines pending the completion of the professional
committee's work.

Another fear, more rarely expressed but frequently
manifested in one form or another, was that the extension

- 221 -

of the Vlan to all trades and industries would lead to a
degree of uniformity rendering the Plan difficult to apply
in particular firms (the "my firm is different" syndrome) .
The danger foreseen is that the inflexibility of a uniform
system would impede the development of accounting as a
managerial information system. The form which this fear
might take was the attempt to set up a professional committee
within an industry or branch, where no technical reason was
apparent. Again, it might lead to the desire to remake the
Flan aomptable general, that is, to reopen issues concerning
definitions, principles and choice between alternatives.
Both of these manifestations of insecurity required tactful
handling; the former in the professional committees them-
selves, and the latter by the Conseil, which was able to
point to its efforts to collect the observations and sug-
gestions made in these circumstances with a view to the
periodic revision of the Plan.

The reticences displayed by members of the committees
as a consequence of these fears were supplemented by others:
the "wait and see" attitude; the disappointment of those who
believed that the adaptation of the Plan was a simple
technical problem, only to discover its concealed diffi-
culties of definition and interpretation; the misunder-
standing of the nature and potentialities of cost accounting
in particular, and managerial accounting in general. It is

222 -

apparent from the two Reports cited that the French
experiment did not benefit from any special advantages in
the field of human relations, other than a v/illingness on
the part of the officials concerned to face important
psychological problems, and to overcome them.

Teahnioal Problems

We have already drawn attention to two technical
problems faced in this experiment: the identification of
an industrial classification under which professional com-
mittees could be formed, and the ascertainment of those
particular features of a trade or industry, whether of
structure or of size, having effects upon the accounts
themselves. In respect of the former,, experience has con-
firmed the wisdom of the decision taken, and a considerable
assistance was obtained from other government agencies
engaged in regulation in carrying out the necessary research,
Indeed, the reports of the Conseil emphasize the importance
of this taxonomic function in arriving at the formation of
committees which do not contain elements capable of ob-
structing the work of adapting the Plan because of their
essential heterogeneity. It is notev/orthy that although
only a small number of industries were subject to this
danger, the risk was regarded as too great to be taken.

The work of the committees revealed that in many
cases the search for a solution of a recognized accounting

- 223

problem led to the discovery of other problems which had
remained hidden, or incapable of clear statement. These
problems may be divided into two classes: problems of
general interest, and problems specific to the industry.
Among the former, it is necessary to decide as and when
they arise whether they require immediate solution, or
whether a solution has to be deferred until the PZan can
be reconsidered as a whole. Among the latter are many
which present themselves in a similar fashion in other
industries, so that the degree of specif icness of the problem
becomes an issue; the representatives of the Conseil have
the task of seeing that exceptions remain exceptional.

One example of this situation may be cited.
Technological change causes firm^s to acquire equipment and
installations of a high degree of specialization, and a
question sometimes arises concerning their conformity to
one of the "fixed asset" classifications v;ithout qualifi-
cation, i.e., under which of the headings of the Plan should
they be included? In the case of oil production it was
decided to open two new accounts specially defined for
the particular case, viz:

213 Specialized installations.
217 Long distance pipelines.

Subsequently, analogous situations arose in other

industries, which showed that the account for specialized

installations could be used in a variety of adaptations

- 224 -

of the Plan; even the pipeline account proved useful for
equipment which, while not identical, was sufficiently
similar to be classified under this account number.

The existence of "free accounts," corresponding
to matrix cells containing zeros, permits a considerable
degree of variation within the Plan, and as long as these
are not preempted by the Plan comptable general they can
be used for purposes specific to the industry, even though
other industries are using them in quite different sub-
classifications within the main class. The use of these
"free accounts" appears to be one of the points at which
pressure on the Conseil builds up.

The existence of firms occupying more than one
industrial classification, called "polyvalent," raises the
problem of compatibility; there must be a high degree of
uniformity between the Plans of the various industries
even though the firm may opt to adopt any one of them.
This situation concerns financial accounting rather than
cost accounting, where the solution is facilitated if the
activities in question are carried out in different
establishments. Nevertheless, the financial accounting
problem is acute where the same account has to be allocated
to different purposes at the same time, and if the firm is ^
big enough it may be necessary to consider it as a subject
for a special secondary adaptation. Where the "polyvalences"

- 225 -

present a certain regularity, as in the case of mechanical
and electrical engineering, or chemicals and pharmaceuticals,
the solution can be worked out in advance, but not where
there is a time-lag in the completion of the work of the
relevant professional committees. In the oil industry,
for example, the production committee completed its work
while the refinery coirimittee was still sitting; liaison
was effected by having a representative of "refining" on
the "production" committee, but the latter 's choices must
impose themselves to some extent on the former's delib-
erations. In view of this and the preceding problem, the
Conseil sees additivity as restricted to the three-digit
accounts , reducing to two digits for inventory and purchase
accounts.

Accounting for research and development was
considered at length by the oil production comrriittee.
While all such expenditures could have been charged to
Account No. 22, the Plan laid down two restrictions:
fictitious values in respect of research which is known
to be abortive should not be shown as assets, and items
previously treated as operating expenses should not sub-
sequently be shown as sources of profit. The solution to
this problem was originally envisaged in the form of a
depreciation adjustment, which could amount to 100% of the
amount capitalized, but opposition from accountants, based

- 226 -

on a suspicion of potential abuses on the part of both
managers and the tax authorities, led to a reconsideration
of this issue, which appears not to have arrived at a
satisfactory conclusion.

^To one v/ill be surprised to learn ti'at int'^r'^*~it on
capital presented another insoluble problem, particularly
in the iron and steel industry, where this iterri assumes
considerable importance. Should some of these costs be
capitalized, either as fixed assets or as organization
costs? and at what accounting cost, since the administrative
work involved cannot be reduced to a simple formula? In
spite of these apparent obstacles , we believe that the
committees will eventually reach satisfactory solutions to
these delicate problems of valuation, because the model
with which they are working is fundamentally sound.

Conclusion

This brief description of the French accounting
experiment shows the application of the accounting model of
the firm to a wide range of commercial and industrial
activities in a manner tending to the elimination of those
elegant variations and unnecessary proliferations which
confuse the analyst and arouse the teacher's ire. The
similarity of the chart reproduced on p. 210 to our Figure 9
in Chapter V is apparent; the differences of detail suggest

- 227 -

a higher level of disagreement than the models in fact
contain, and we prefer the chart in Figure 9 merely on
grounds of convenience for presentation and explanation.
We are thus confirmed in our view that Figure 9 represents
an acceptable image of reality, and one on which a new
theory of accounting can safely be constructed.

NOTES

1. Decree No. 47-2051 dated October 22, 1947. See
Bernard M. Berry, "Uniform Accounting in France:

Le Plan Comptable," London, The Aoaountant , Vol. 140
(February 26, 1949), pp. 157-61; and (March 5,
1949) , pp. 176-80.

2. Plan aomptahle general (Paris: Imprimerie Nationale,
1957) .

3. Pvemiev Rapport Sur I ' Appliaation Progressive du Plan
Comptable General (Paris: Ministry of Finances and
Economic Affairs, July 1, 1963).

4. Ibid.

5. Kenneth S. Most, "Uniform Accounting in France,"
London, The Aoaountant (November 23, 1957), pp. 594-6.

6. Plan comptable general, p. 9 (our transl.).

7. I&id.jp.l3.

§. Deuxieme et Troisieme Rapports Sur I ' Application
Progressive du Plan Comptable General (Paris:
Ministry of Finances and Economic Affairs,
December 31, 1965).

9. Ibid.

10. See Feasibility of Applying Uniform Cost Accounting

Standards to Negotiated Defense Contracts , Comptroller
General of the U. S., Government Accounting Office,
Washington (January 19, 1970).

- 228

CHAPTER VIII
ACCOUNTING THEORY AND ECONOMIC DEVELOPMENT

In the first chapter of this work we started with
a postulate that the behavior of individuals in a society
may be studied in relation to both consumption and investment,
which, being distinct modes of behavior, must be kept sep-
arate in any formal analysis. We are, therefore, postulating
a conflict of needs underlying the problems of resource al-
location, but of a somewhat different nature from the con-
ventional economic classification into consumption and
saving. The form of this classification is given by
Marczewski as follows:^

1. Individual present needs = Consumption

2. Individual future needs = Private capital for-

mation

3. Collective present needs = Current production of

consumption goods

4. Collective future needs = Current production of

investment goods

By elevating the discussion to a higher level of
abstraction, we can treat the financial concept of private
capital formation as personal saving, and arrive at a
purely subjective classification of goods into aonsunption , '
and investment . Production refers to processes and not
resource allocations. Marczev/ski ' s classification then

- 229

230 -

becomes: individual present and future needs (consumption
and saving) , and collective present and future needs
(investment) . The conflict between private and public
consumption, saving, investment and production, is seen
to be a second order question, to be resolved, in a free
society at least, on issues of efficiency and economy.

In order to relate accounting theory to economic
development, we shall assume a State in which_ the ideo-
logical conflict between private individual needs and public
individual needs is replaced by the economic question of how
shall given needs be satisfied at the lowest social cost,
defined as sacrifice of resources. It is further assumed
that, in order for needs to be placed in a hierarchy for
purposes of decision, they can be quantified by means of
a system of money valuation. It may be shocking to some
if we suggest that human needs can be represented in money,
but observation reveals that we do arrive at money values
for a wide range of noncomiTiercial situations — student
bourses, accident compensation, artistic performances,
charitable services — and that these valuations are no dif-
ferent in kind from any others, being subjective judgments
made objective by interpersonal agreement. VJere we to
adopt any other method of establishing priorities, it could
lay claim to no higher degree of acceptability than this.

- 231 -

Three liberating events which are nowhere celebrated,
but which underlie the benefits enjoyed by free men every-
where, are,, in order of occurrence:

1. The valuation of personal services, in the form
of wages, whereby men were enabled to separate
their work from their personalities, and thus
escape from slavery.

2. The valuation of ability to perform contracts, in
the form of credit, v/hereby able men were placed
in possession of resources to which their birth
and position gave them no rights.

3. The valuation of impersonal services, in the form
of depreciation and amortization generally, which
extended the scope of money valuations t.o virtually
all problems concerning the allocation of scarce
resources .

In the year 2,000 A.D., when money as a means of

payment will have lost its significance, and when property

rights as the 19th century knew them, will have virtually

disappeared, the twin functions of accounting will finally

assume their full importance: the attest function, which

has been described as "telling managers what they already

know," and rendering valuations objective for the benefit

of third parties, which comes under the general heading of

financial reporting. In order to see why this should be

so, we shall review our theoretical formulations.

A New Tkaory of Aacounting

We have based our nev/ theory of accounting on the
observation that men use accounts for purposes of prediction,

232 -

planning and control. We have, therefore, directed
attention away from the conventional list of assumptions
required by accounting theorists — ^profit maximization,
income determination, double-entry bookkeeping, the going
concern, the entity, attaching and matching — and toward the
account, use of which distinguishes accounting from all
other forms of planning and control.

The account displays the following characteristics:

1. It is in two parts, one for in-flows, one for
out-flows .

2. It is a complex cf form, and content.

3. It contains observations concerning value and time,
expressed in a given language and manipulated with
the aid of arithmetical techniques.

It follows from this that the concept of a "stock"
account is redundant; all accounts deal with flows in the
sense of changes between one point in time and another. The
balance sheet, which is an account for the business at a
particular point in time, simply abstracts from time, since
a point has no dimension, but it does not thereby convert
flows into something else, or arrest the process of change
which accounts are designed to represent. To attempt to
construct separate models for stock variables and flov/
variables is another of the logical errors to which we have
drawn attention in this work.

The purely technical features of the account,
including the way in which a multitude of accounts can be

- 233 -

manipulated as a system, are generally understood; they
have been converted into algebra by Ijiri, Mattessich,
Cooper and others, and into vectorial notation by Mattessich.
The results are clumsy, and there are, in fact, no mathe-
matical processes which can accomplish what accounts can
do, namely, quantify and date movements of values; the
best that mathematics can do is to make drastic simplifying
assumptions, such as, that everything happens at the end of
the month, or that events take place with some form of
regularity.

The obscure feature of the account, and the one
which underlies the criticisms of accounting summarized by
Mattessich,^ is valuation. We have emphasized the sub-
jectivity of valuation, v;hich permits "historical costs"
to become "opportunity costs" if the interested parties
so agree, and v/hich converts "arbitrary" allocations into
"allocations, the reason for which I fail to understand."
We have also indicated that the valuations usable in ac-
counts are restricted only by hum.an imagination and ability
to agree, so that the criticisms of accounting as too narrow,
or lacking in behavioral functions, can be dism.issed as
criticism of accountants.

Before drawing our conclusions on the subject of
valuation and the additivity of values, we wish to point
to the implications of the accounting theory outlined above
for the teaching of accounting, and for accounting textbooks

- 234 -

in particular. The acceptance of our emphasis on planning
rather than control will lead to the preparation of text-
books in which budgeting precedes financial and cost ac-
counting for transactions, rather than the other way round,
as is now invariably the case.^ The abandonment of unneces-
sary assumptions, and the acceptance of the subjectivity of
valuation, must effect a radical change in the contents of
these texts, to appreciate the enormity of which it suffices
to state that they will omit such timeworn propositions as:
that revenues are receipts from sales; that costs are money
payments; that liabilities are amounts ov^ed; that assets are
things owned having value to the owner; that costs attach;
that costs are to be matched with rex/enues; that profit is
business income; that cash flows.

Value and Additivity

The contents of this study suggest strongly that
economists and accountants may have been mistaken when they
assumed that their subjects were akin to those physical
sciences in which mathematical logic has been used with such
striking success. It is more probable, we think, that ac-
counting can be compared with ecology in that it depicts a
complex of relationships between man and his environment,
any one of v/hich may, at a particular moment in time, assume
a critical importance for the achievement of his goals.
Ecology is unlikely to produce the spectacular discoveries

- 235 -

which other departments of science have accustomed us to
expect, yet it is indispensable to man's survival. Ac-
counting appears pedestrian to some, but it may likewise
be indispensable to the formal acts of planning and control
which modern industrial man has found it increasingly useful
to undertake.

The difference between the two approaches to science
is best revealed by the contrast between measurement and
valuation which was brought out in Chapter V, where we
identified the subjectivity of value as a critical elem.ent
in accounting methodology. Values are made objective by
interpersonal agreement, of which the formation of prices
in m.arkets is simply a special case. The subjectivity of
value has long been recognized in security markets:

There is no such thing as a final answer to security
values. A dozen experts will arrive at 12 different
conclusions. It often happens that a few moments later
each would alter his verdict if given a chance to re-
consider because of a changed condition. Market values
are fixed only in part by balance sheets and income
statem.ents; much more by the hopes and fears of
humanity; by greed, ambition, acts of God, invention,
financial stress and strain, v/eather, discovery,
fashion and numberless other causes impossible to be
listed without omdssion.'*

The adoption of accounting methodology for planning

and control, which this feature of valuation makes possible,

depends for its usefulness on the systematic representation

of real processes whereby needs can be satisfied, and in

Chapter V we presented a model within which investment and

the processes of production can be analyzed, both in the

236 -

private and public sectors. In Chapter VI we attempted to
show how this model can be extended to social accounting,
so that the system can be related to the consun\ption needs
of a society as well as its investment and production
processes. It appears to us that there is a definite limit
to the use of accounting methodology in the area of con-
sumption, and that logical and procedural problems, which
are not capable of being solved in the present state of
human knowledge, must arise if the attempt is made to extend
the use of accounts in this area beyond the conceptual
boundaries of acquisition and disposal.

In the Soviet system of social accounting, which
reflects a policy of giving priority to the collective over
the individual on purely ideological grounds, the basic
materials of the planner are data on physical resources,
divided into labor, materials and productive capacity.
The relation between disposable and allocated resources
uses techno-economic coefficients, recalling Leontief's
^ik coefficients; the latter, however, are simply static
interindustry deliveries as parts of total output, both
at constant prices. The differences between the Soviet
balances de ressouroes en nature and Leontief's inputs and
outputs are as follows:^

1^ The former relate to a single, well-defined,
factor or product, in the form:

- 237 -

Opening balance + current production + imports

= disposable

and

Investment + consumption + exports + reserve
= allocation.

Leontief is concerned principally v;ith outputs,
although these become the inputs of succeeding
industries and sectors.

2. They are measured in physical units, where Leontief
uses money measures.

3. They are prepared for three successive years (past,
current and next) .

4. Labor resources include all those of work age,
including students, who are allocated to edu-
cational institutions.

5. The Soviet balances are analyzed by regions and
not simply by industries and sectors.

We do not envisage the adaptation of the Soviet
system to the planning requirements of a free society, not
only because V7e regard planning in this sense as incom-
patible with the freedom of the individual, but also because
we have serious doubts whether values can, in fact, be
broken down into quantities and prices , the two elements
being inseparable in the majority of valuation situations.^

This leads us to a consideration of the additivity
of valuations « Many accounting theorists and practitioners
have criticized financial statements inter alia on the
grounds that they contain measurements of different qualities
("direct" and "indirect" valuations, for example) or in
dollars of different epochs, representing different

- 238

purchasing power equivalents. These critics assume that
the additivity of accounting data would be improved by the
adoption of a homogeneous class of valuation models,' or
by price level adjustments using indices. Morgenstern, on
the other hand, has suggested that a balance sheet (by
which he presumably means a complex of financial statements
based upon balance sheet concepts) is a cell containing a
"single hard core or kernel of accurate figures to which
the ordinary ideas of errors apply, surrounded by succes-
sive layers of figures gradually farther and farther away
in character from the core because of the manner in which
they are conceived, although in outward monetary appearance
indistinguishable in their presentation, even down to the
last decimals. An aggregation from several balance sheets
is, therefore, the summation of such information: only
the arithmetic sums of the kernels can have a claim to
'accuracy' to which the customary notions of error can be
applied."® He thus saw a serious statistical problem in
the development of a theory capable of handling such data,
and in a subsequent edition of the same work, on the basis
of an assumption that current cash realization equivalents
are the measurement to be approximated, he proposed a
probabilistic structure of assets in which mathematically
expected values can be stated together with standard error
measurements . '

239 -

Since we see the accounting use of money as a
measurement of value and a unit of account, and not in the
first place as a means of payment or an asset, we can see
little usefulness in financial statements prepared on the
basis of current cash equivalents, except in the case of a
business or a part of a business for which liquidation is
imminent. We regard accounts as sets and subsets of values,
so that the possibility of performing mathematical oper-
ations other than simple aggregation is a function of the
homogeneity of the observed realities underlying the values
which an account or accounts contain.^" The degree of
homogeneity which permits simple aggregation is dependent
on interpersonal agreement to that end, and cannot be
rendered objective in any other perceptual sense. An ac-
count for land and buildings, for example, may aggregate
valuations of real properties in different locations, subject
to different legal restrictions, and available for dif-
ferent economic uses; their expression in homogeneous
physical quantities (square or cubic feet, quantities of
brick, timber or concrete, or quantifiable descriptions of
operating machinery) does not permit us to assume that
their values are additive. One man may aggregate these
values for his purposes without let or hindrance; a group
of interested individuals m.ay add some and exclude others,
or simply fail to agree on any additivity whatsoever . ^ ^

- 240 -

We are in substantial agreement with Shackle on
this point, who rejects the applicability of probability
theory to investment valuations . ^ ^ In his view, the
formal theory of investment in economics involves an as-
sumption of certainty, so that there is no risk of a non-
receipt, or, at worst, a measurable risk which we may call
"certainty equivalence." The nature of investment decisions
is to deal v;ith a range within which there is. "complete and
unqualified indeterminancy" ; if the expected earnings of a
piece of equipment constitutes a range of equal possibili-
ties, with no probability assignment possible, then an
individual will choose the largest estimate as a working
hypothesis, because this is most attractive to him. We
would simply add to this that a group of individuals who
wish to reach agreement on value for the purpose of an
investment decision in which they are all interested may
choose a value below the largest estimate, which will be
the highest to which they can all, in good conscience, agree,

The Importance of Accounting in National Planning

The modern state v/hich seeks economic development
experiences a dilemma from which there appears, at first
sight, no escape. Forced to compete at one and the same
time with the most advanced nations in its industrial
markets, and with the most backward or underpopulated with

- 241 -

its agricultural products, its leaders may conclude that
only by keeping industrial wages low and by collectivizing
agriculture can the country produce at a cost which will
permit exports to finance the necessary imports of plant,
machinery and raw materials. The key to this policy, how-
ever, which is the restriction of personal consumption
through keeping down disposable incomes, is constantly under
pressure from another aspect of modern international rela-
tions, the rapid flov; of ideas. Radio, television, films,
books, magazines and personal contacts stimulate the tastes
and appetites of the poorest and least energetic of the
world's populations as well as those of the wealthy and
thrusting. The people desire costly distractions, consumer
durables, fashion garments, exotic foods; either the drive
to higher vzages and imports of noninvestment goods frustrates
the development policy, or else the country collapses into
a totalitarianism from which, as far as we knov;, there may
be no return.

There is, however, one solution which may offer some
hope to those developing countries which have not yet sur-
rendered to the tyranny of the corporate state. The indus-
trial and agricultural nations with which they must compete
are frequently inefficient in their methods; great wealth
leads them to overinvestment or uneconomical production;
or the large scale of their productive apparatus renders
them, inflexible and insensitive to changes in demand;

- 242 -

or a preoccupation with considerations of prestige and
vainglory causes them to squander their resources in search
of "the bubble reputation." The developing state, aware of
these possibilities, will seek to foster its competitive
advantages by specialization in those areas where
flexibility is at a premium, and by eliminating waste in
both private enterprises and government agencies.

If, as we have suggested, accounting is a planning
and control methodology, then it is reasonable to see in
the attention which some developing countries have paid
to founding or strengthening their accounting professions,
a recognition of this fact.^^ The need to value, which
lies at the base of all investment decisions, including
current decisions relating to ongoing production, leads to
the choice of a planning model in which values are explicit
variables; the time constraint which is imposed by changing
consumer expectations leads to the choice of accounts,
which make time an explicit variable. As long as the
model is used scientifically, with the correspondance
betv/een the abstraction and its underlying reality con-
tinually verified, it can be a useful tool for economizing
in the voider sense of the word, that is, for minimizing
the input requirements for any given output.

In those developed or industrialized nations where
investment is delegated, by conscious political choice, to
the level of society at which cost and benefit can be most

- 243 -

clearly perceived, we can see many useful purposes being
served by a social accounting which proceeds from the
identification of the plans of the various sectors, indus-
tries and branches of the population. The presentation of
these plans as a consolidation of accounts permits the
establishment of divergencies between aims and achievements
in terms of society as a whole, and allows the regulatory
agencies of government to intervene rationally and consist-
ently in order to remove those obstacles which stand in
the way of the fulfillment of individual economic_ goals.
Even the consolidation of "historical" accounts divorced
from a comparison with "planned" accounts can yield results,
in the form of questions, the answers to which may aid in
the resolution of social conflicts, and information which
individual planners can rely upon as points of departure
for their personal projections and decisions. We do not
believe, however, that the full potentiality of even this
restricted aspect of social accounting is capable of
achievement with the models in use at the present time.

Conclusion

In conclusion, we may restate the preoccupations
which have rendered necessary this new approach to ac-
counting theory in order to determine the relevance of
accounting to the economic development of the modern state.

- 244 -

Economic activities of production and distribution are no
longer characterized by regular exchanges in markets.
Many of them require long periods of time to elapse between
inputs and outputs, frequently several years and in some
cases much longer. Many of them by-pass markets entirely
for long periods of time, as for example, the integrated
production and marketing operations of the international
oil corporations; the production and distribution operations
of public institutions transact only on input markets, and
obtain many of their inputs from nonmarket sources. Some
huge defense contracts are negotiated under conditions
which make reference to markets meaningless. The tendency
for economic activities to be concentrated in large public
and private production units, with clearly separated finan-
ciers and managers and well-defined hierarchies within each
of these categories, renders psychological assumptions ap-
plicable to tenant-farmers or town locksmiths of dubious
relevance.

"Betv;een the inhumanity of the marginalists and
the inhumanity of the marxists, is it impossible to con-
struct an economic science truly that of man?" asked
Marchal.'''* He thought so; we would gladly prove him wrong,
and to that end this study is humbly dedicated.

NOTES

1. J. Marczewski, Flanifieation et Croissayioe Eaonomique
dee Demoaj-'aties Populaires , Vol. II (Paris: Presses

■2. Supra, Ch. II.

3. R. N. Anthony, in Management Accounting (Homev/ood:
Richard D. Irwin, Inc., 1956), has acknov7ledged the
logic of this position, on p. 2.

4. Gerald Loeb, The Battle for Investment Survival,
quoted by 'Adam Smith,' The Money Game (New York:
Dell Publishing Co., Inc., 1967), p. 22.

5. Marczewski, II, p. 450. The problem is demonstrated
mathematically by him on pp. 453--67.

6. Robert R. Sterling, in "Elements of Pure Accounting
Theory," The Accounting Review ^ Vol. 42 (January,
1967), pp. 62-73, suggests that "historical cost"
accounting can be explained on the grounds that
quantities and prices are separable phenomena.

7. E.g., Edgar 0. Edwards and Philip W. Bell, The Theory
and Measurement of Business Income (California,
1961) .

8. Oscar Morgenstern, On the Accuracy of Economic
Observations (1st ed . ; Princeton, 1950), p. 31.

9. Ibid. (2d ed . ; 1963), pp. 76-79.

10. G. E. M. de St. Croix provides evidence that Greek

accountants regarded the values they recorded as sets,
e.g., the building accounts of the Parthenon, 434-
433 B.C., V7hich contain observations in different
currencies. See "Greek and Rom.an Accounting," in
Studies in the History of Accounting , ed. A. C.
Littleton and B. S. Yamey (Homewood: Richard D.
Irwin, Inc., 1955) at pp. 23-4.

- 245

- 246

11. The published consolidated financial statements of

General Motors, Inc., for example, do not add together
the real properties of the raanufacturing corporation
and its divisions with the real properties of General
Motors Acceptance Corporcition, although the latter is
a wholly-owned subsidiary of the former.

12. G. L. S. Shackle, "The Nature of the Inducement to
Vol. VIIT, No. 1 (October, 1940), pp. 44-8.

13. "Relations between an underdeveloped country and the
rest of the world are not generally favorabie to
spontaneous industrialisation." Marczewski, II,

p. 435 (our transl.).

14. J. Marchal, Cours d'Eao-nornie Politique (Paris:
Librairie des Medicis, 1952), p. xi (our transl.).

APPENDIX

Werner Sombart. Dev Moderne Kapitalismus . 3d ed. Munich
and Leipzig: Duncker and Humblot, 1919, Vol. II,
1st half. Chapter X, "The Birth of the Capitalist
Enterprise," pp. 110-3 6

Translated by Kenneth S. Most

III. The Business as Aaaounting Entity: The ratio (account)

1. The historical development of accounting . — ^The
introduction of accounting was of the greatest significance
for the full development of the capitalistic enterprise.

We know that the artisanal organization of medieval
trade (and anything like bookkeeping was unthinkable for
other branches of business life) found its expression in an
incomplete and highly personalized bookkeeping. The sparse
and confused collection of notes v/hich characterizes the
German trade books of the 14th and 15th centuries had, as
sole object, to recall to the m.emory of the business manager
particular events and conditions in his business. The books
were memoranda in the most primitive sense of the word.

The public household was the place where an organ-
ized or "objective" bookkeeping, comprehensible to third
parties took root.

Naturally, the Italian city communities took the
first steps. From the 13th century on, perhaps even ear-
lier, orderly business management starts to appear. In-
ventories of m.ovable and real property are taken, the tavcle
delle posseasioni in Florence, in two copies; special of-
ficials (nctai) are appointed to provide annual reports on
the public debt (Milan, Pisa, Florence) . Strict supervision
of communal receipts and payraents is introduced. In 1225
the Milanese Fodesva orders a monthly check on the govern-
ment cash and requires officials to submit monthly accounts.
All statutes contain bookkeeping regulations: the Breve
pisano of 1286, for example, requires two separate books,
one for receipts and one for payments; in Venice monthly
audits and surprise cash checks shall take place. Balance ■
sheets were constructed for the Italian states in the 14th
century: we have them for Florence from the years 1336-38,
for Treviso from 1341, for Rome from 1358, for Milan from
1463

248 -

- 249

An earlier accounting regulation v/as forced upon
the papal household, thanks to its extraordinarily high
receipts, and also on the French and English royal house-
holds .

In the private profit sector the bankers were
probably the first to keep accounts systematically, because
of special features of their business. The laws of cities
such as Pavia, Piacenza, and Novara, indicate the exacti-
tude of their accounts. In the 14th century, city admini-
strations were told to keep their books in the manner
customary in banking circles. What was that? and how did
bookkeeping grow into a highly organized system?

The history of accounting must begin with the
sentence: in the beginning was the account: the ratio.
We rightly refer to the study of bookkeeping, even today,
as accounting, and both the French and Italian languages
use this word: accounting, to designate the whole subject
of bookkeeping: aom-ptahilite , vagione'^ia . IVhat is true
of the entire system is true to an even greater extent of
its beginnings; accounting grew by means of constructions
using accounts; by putting them into accounts, the writer
of an unanalyzed and personalized collection of notes broke
them into two parts and built them into a firm sequence of
thoughts, on which all subsequent accounting could be based.

We can accept on the basis of the ev'idence available
to us that accounting constructions were developed in 13th
century Italy, and that, in France in the 14th century, real
accounts were to be found side by side with personal accounts,
which originally existed on their own. [Evidence cited.]

The second step in the development of accounting was
double-entry: the German Doppik or the French loi ^digraph-
ique , whereby every item is recorded on opposite sides of
two accounts, so that one account is debited with the same
amount with which the other is credited, on which double-
entry bookkeeping, la pavtita doppia, la aomptabilite a
parties doubles is based. Through double-entry bookkeeping,
the entire accounts of a business are tied together, as a
bundle of sticks with string.

The time when this step V7as attained appears to have
been the second half of the 14th century. The city admini-
stration of Genoa v/as already keeping its books of account
on the double-entry basis in the year 1340, and according

- 250

to H. Sieveking, the old account books of Soranzo, which
fall within the 14th century, were kept on the double-entry
basis. It is well known that double-entry bookkeeping was
later known as the "Venetian style," and v^e can deduce from
this that it first saw its construction (or use?) in Venice.

However double-entry, the loi diagraphique ,
characterizes accounting, the use of this principle does
not suffice to complete the system. True, the essential
nature of double-entry bookkeeping, which undoubtedly con-
sists in following the complete circular flow of capital
through a business and measuring and recording it, is not
apparent until the system of accounts is complete. We know
that this is not the case until, side by side with the other
accounts, a profit and loss account and a capital account
enter the picture, to which the balances of the other ac-
counts are carried; without this, the accounts remain dis-
connected. The circular flow of capital which double-entry
bookkeeping is designed to embrace can only be shown in full
when these accounts are put in place: from the capital ac-
count to the transaction accounts through the profit and
loss account and back into the capital account.

Historically, this completion of double-entry
accounting took place in two steps: the first led to the
introduction of the profit and loss account; the second,
finally, to the creation of a capital account. The
Soranzo 's new ledger, which belongs to the 15th century,
has a profit and loss account but no capital account; the
account book kept by Andrea Barbarigo in 1430/40 has a
capital account at the end.

Here, not only are the goods accounts regularly
closed to the profit and loss account, as in the Soranzo 's
new ledger, but the profit and loss account is also for-
mally closed out to the capital account: the accounts of
1430 and 1432 feed the account of 1434. The balance of
this account is credited to the capital account "Andrea
Barbarigo."

In the beginning of the 15th century, then, came
the first scientific system of double-entry bookkeeping, in
the theoretical framework of V7hich all subsequent practical
achievements were to be fully accoirmodated. The system of
Fra Luca (Pacioli) published in 1494, which has kept its
fame in spite of all researches into the history of ac-
counting, earned for him the title of first bookkeeping
theorist, iZ prima autore di ragiomvia .

- 251 -

[Bibliographical note, in which Sombart points out
that Pacioli's double-entry did not grow out of single-entry
bookkeeping, the latter being a crippled version of the
former, and of later date.]

Even though the system of double-entry bookkeeping
was virtually complete in Pacioli's version, it was far
from being the highly-developed and organized system we know
today. One shortcoming, visible in Pacioli and in the 16th
century writers, was overcome simply through practice: the
process of balancing the books; only by means of this pro-
cess can the latent interrelationship of the individual ac-
counts be made manifest. Pacioli does not mention balancing
or annual closing. Simon Stevin (1608) was the first to
require that the books be closed annually, besides at the
merchant's death and when the business was liquidated. Even
with this, however, a real problem remained.

This real problent, it is known, is that the profit
or loss calculated from the balances of the other accounts
is fictitious and not true, because two conditions have been
disregarded vjhich materially affect the size of the actual
profit or loss: 1. the fact that during the accounting
period, part of the overheads cannot be exactly determined;
2. the fact that, from the moment of their entry into the
business, values may (and in most cases do; diminish. If
profit or loss is to be accurately determined, then all
values must be reported as at the moment of balancing, and
this is the purpose of the inventory. "Thus, the final trial
balance is dependent upon an operation external to the book-
keeping system, namely, the inventory."

If the bookkeeping theorists of the 17th century
called for the books to be closed annually, and a yearly
balance sheet, it was for essentially bookkeeping purposes;
as in the case of de la Porte, it was a purely mechanistic
function or, as Schar correctly states, "an accounting trick,
an equivalence of identities." When was the need for an
inventory recognized? It was long thought that the idea
of a closing inventory appeared about the end of the 17th
century — at the same time — otherwise the French Ovdonnanae
of 1673 could not have made such an inventory a legal obli-
gation.

Article VIII of Title III of the Ordonnance lays
down, in fact: Seront aussi tenus tons les Marahands de
faire dans meme delai de six mois, inventaire sous leur
seing de tons leurs effets mobiliers et immokilievs ^ et de
teuTs debtzs aat-ives et passives , te quel seica recolle et
renouvelle de deux ans en deux ans .

- 252 -

It is tempting to ascribe this idea to the two
Savarys, who were known to have fathered the 1673 Ordon-
nance de Commerce^ and who provide a very detailed com-
mentary on this regulation in their scientific works, Le

par fait negociant and Dictionnaire de commerae.

On closer examination, however, it appears that the
view that the two Savarys, in their works or through the
provisions of the 1673 law, saw the closing inventory as a
complement of double-entry bookkeeping, is false. The
inventory which they called for and for which an exact
valuation was required, applied only to retailers, who did
not keep double-entry books and for v;hom this inventory was
designed to act as a substitute. The usage of the time
restricted the word "marchands" to retailers ,. and the
Savarys always refer expressly in their works to "marchands
en detail." Businesses which kept double-entry books re-
tained the purely accounting balancing operation: the
opening balance sheet, when the books were closed*, at the
end of the year, was buried by the new balance sheet: it
took the place of the inventory: quand un marahand ou
negociant tient ses livres en parties doubles, le bilan
d' entree lui sert d' Inventaire , qu'il porte au oommenoemsnt
du nouveau Journal et du nouveau grand livre . (J. Gavary,
Dictionnaire de Commerce , 2, 438.)

Nor do we find in the 18th century a requirement to
ascertain values by taking an inventory. Not even Biisch
requires an inventory but leaves goods in the balance sheet
at their purchase prices. G. H. Buse (1804) compares the
quantities in inventory v/ith the differences between pur-
chases and sales, but uses purchase prices only.

Can it be true that the age of early capitalism
ended without establishing the idea of a non-accounting in-
ventory as a necessary element in the complete system of
double-entry bookkeeping? The question will have to be
answered by research specifically directed to that end.
We are content here to have established that the system of
double-entry bookkeeping was fully developed during the
early capitalist period. Let us see what basic signifi-
cance this new form of business organization had for the
creation and expansion of the capitalistic enterprise.

2. The Significance of Accounting in the Development
of Capitalism. — Order increases our strength, not least in
economic affairs. "Order and clarity increase the desire
to save and to acquire wealth. A person who manages his
affairs badly feels well in the dark; he does not want to

- 253

add together the bills he owes. The good manager finds
nothing more pleasant than to check the totals of his
growing wealth daily. Not even an unfortunate accident
frightens him, for he knows immediately the advantages
which he can place on the other side." This generalization
is applicable to all economic conditions; to the farmer
as well as to the craftsman, to the capitalistic enter-
prise as well as to the housewife. The conviction that
order strengthens the economic mind leads to the vivid
realization that the very special organization of busi-
nesses through accounting is inherent in the development
of capitalism. It is hard to imagine capitalism without
double-entry bookkeeping: they belong together like form
and content. And we may well question whether capitalism
found in double-entry bookkeeping a tool with which to
apply its forces, or whether the spirit of double-entry
bookkeeping first gave birth to capitalism.

Double-entry bookkeeping! No textbook of this
science or art can fail to quote the proud words (not
Goethe's, however) of Wilhelm Meister's brother-in-law:
"It is one of the most beautiful discoveries of the human
spirit and every good housekeeper should introduce it into
his economy." I believe that one can truly understand this
observation of Werner the businessman only if one does not
read the second phrase: "Every private household would do
well to use double-entry bookkeeping," but rather under-
stands him to explain double-entry bookkeeping as one of
the most grandiose and consequential inventions — ^rather
creations — of the human spirit. If its significance is to
be correctly understood, it must be compared with the
"knowledge" which scientists have built up since the 16th
century, concerning relationships in the physical world.
Double-entry bookkeeping came from the same spirit which
produced the systems of Galileo and Newton, and the sub-
ject matter of modern physics and chemistry.

By the same means it organizes perceptions into a
system, and one can characterize it as the first cosmos
constructed on the basis of mechanistic thought. Double-
entry bookkeeping captures for us the cosmos of an economic,
more precisely, a capitalistic world by the same means that
later the great natural scientists used to construct the
solar system and the corpuscles of the blood (or captures
us, v/hich means the same thing). Double-entry bookkeeping
is based on the methodological principle that all percep-
tions will be manipulated only as quantities, the basic
principle of quantification which has delivered up to us

254 -

all the wonders of nature, and which appeared here for the
first time in human history in all its clarity. Without
too much difficulty, we can recognize in double-entry book-
keeping the ideas of gravitation, of the circulation of the
blood, of the conservation of energy and others which the
physical sciences have discovered. And even — I v/ould say —
on a purely aesthetic plane we cannot regard double-entry
bookkeeping without wonder and astonishment, as being one
of the most artistic representations of the fantastic spir-
itual richness of European man.

More important to us here is to measure the influence
which the new system had on the course of European economic
life. I would like to put this thought into the foreground:
that because of double-entry bookkeeping, conditions v/ere
created which permitted the essential ideas of the capital-
istic economic system to be fully developed: the creation
of wealth and the idea of economic rationality.

The idea of creation of wealth is developed in
double-entry bookkeeping to the point where the "wealth
producing sura," that is, the am.ount invested for the pur-
pose of obtaining profits , is separated from all natarai
objectives of human vrelfare. In double-entry bookkeeping-
there is only one objective: the increase of a sum of
money, expresL^ed in purely quantitative terms. He v/ho
buries himself in double-entry bookkeeping forgets all quan-
tities of goods and work, forgets all the organic limita-
tions of the necessity to satisfy human -v/ants , and satisfies
him.self solely with the idea of wealth: he cannot do other-
wise if he is to understand this system: he may not see
shoes or ships, corn or cotton, but only sums of money which
grow bigger oi" smaller.

[Quotation fromi Seidler.]

This manner of looking at things first led to the
concept of capital. One can thus say, that prior to double-
entry bookkeeping there was no such category as "capital,"
and that without it, capital would not exist. We can in
fact define capital as the property of wealth which a double-
entry bookkeeping system embraces.

In close connection to this lies another thought:
that it led to the first full rationalization of economic
life, insofar as one of the external signs of this ration-
alization is the tendency to make people accountable for

- 255 -

all stages of the economic process. Here we see the close
relationship between the overriding wealth-creating prin-
ciple and rationality; both dissolve the economic world in-
to figures, one to state its objective as the increase of
wealth, the other to aid in its achievement. How very much
accountability is affected by double-entry bookkeeping is
obvious: the latter recognizes no economic processes out-
side the books of account: quod non est in librisj non est
in mundo '. to get onto the books, a thing must be capable
of expression in terms of money. But money is represented
by figures, so that every economic process must correspond
with a figure; production and consumption become calculation.
In accordance with this viev;point, auxiliary expressions,
are created. Thus we see the class of concepts known as
"exchange value" take shape, which are handled extensively
only within the framework of an accounting system.

But rationalization of the economy is aided toward
the other two directions in which, as we have already seen,
it seeks to operate: double-entry bookkeeping serves also
the purposes and plans of management.

It has been correctly pointed out that it provides
the first full insight into the shortcomings which miay af-
fect an economic organization, so that it is also a con-
dition precedent for a progressive, systematic improvement
of the operations of a business. Through the separate treat-
ment of the individual departments of an undertaking, every
single element of success or fortune can be shown in the
various accounts. It has also been correctly remarked that
the far-reaching planning activities of the undertaking are
also assured by its bookkeeping. "L 'importmice de la Com-
tabilite aonsiste non seutement dans t' etude de I'activite
eooulee d'une entveprise , mais enaore dans les indiaations
qu'elle fournit pour la direction future. D'apres I 'obser-
vation et I'etude des causes et consequences des eve^iements
accomplis, elle donne la possibilitS de prejuger I'activite
future et de trouver des bases sures pour raisonner les ac-
tions a venir." (L. Gcmberg , La science de la comptabilite
et son systeme scientifique , 1901), p. 36).

In pursuing its objectives,, it creates the conceptual
framework, or helps to create it, with the aid of which we
are accustomed to grasp the nature of a capitalistic econ-
omy: the classes of fixed and circulating capital, costs
of production and other concepts arise from the use of the
basic ideas of double-entry bookkeeping, and without them

- 256 -

would probably not have arisen, or would be much less clear;
the scientific equipment of micro- and macro-economics,
insofar as they relate to capitalist economies, has (often
unconsciously) been taken over, in great part, from the
storehouse of double-entry bookkeeping.

As double entry bookkeeping first created the concept
of capital, so it simultaneously created the concept of
the capitalistic enterprise as that economic organization,
that institution, v/hose object is the evaluation of a
particular capital. Indeed, here at the birth of the
capitalistic enterprise, the creative cooperation of double-
entry bookkeeping appears most obvious. We have estab-
lished that the essence of the capitalistic enterprise as
an assemblage of property m.ust be seen to lie in the
separation of the business from its owners. The book-
keeping system substantially aids this separation of the
business .

It operates this separation in two respects; by
liberating the accounts and with them the management of
the business from the person of the businessman, and by
ordering them in accordance with pure].y material consid-
erations". The preparation of the accounts becomes ob-
jective and mechanized. Objective because the procedure
is generalized and made independent of the accidental
characteristics of the businessman's person; made repre-
sentative, customary, so that wherever it may be used,
it is comprehensible to all. In the trade books of the
Middle Ages only the proprietor of the business could
(and should) find his way; every qualified person can
understand a systematically kept set of books. For this
reason, the founders of double-entry bookkeeping laid down
the principles of clarity and comprehensibility . Thus,
Luca Pacioli in Chapter 12: "Close each journal entry by
drawing a line from, the end of the last word of the
explanation of the entry to the figures obtained. You
will do the same in the Memorandum, drav;ing a single
diagonal line through each entry in this manner, "//"
showing that the item has been entered in the Journal.
Should you not wish to draw this line through the entry,
mark through the first letter at the beginning of the
entry, or the last letter at the end. In any event, use
som.e sign by which you understand that the item has been
transferred to the Journal.

"Although you may use various expressions and
signs, you must nevertheless attempt to use those common

257 -

to otiier b'asinessmen, so that yovi will not appear deficient
in the usual bu^inesB customs ."

[From the translation by R. Gene Brown and Kenneth S.
Johnston^ New York, McGrav;-Hill Book Co., Inc. (1963).]

Moreover, by laeans of double-entry bookkeeping,
accounting is net only riiado objective, it is mechanized.
Once begun, account j-.n-g can jJs camev_<. on in a pari_iCuj-ar
direction. Schar characterises this feature of double-
entry bookkeeping well, saying that it converts accounting
into an "eutoraatic system." {Zwanyslaufigea System),

As business management ceased in this way to be
a highly personal affair, in the place of personal
management v;e find the substitution of impersonal manage-
ment; the business replaces the entrepreneur as an in-
dependent entity, moved by its own internal laws. Further,
it does so in two senses: in that the business, repre-
sented by its capital, appears as an entity, through its
incorporation in the accounting system; and in that the
person of the entrepreneur is shown clearly to be separate
from the entity "the business," and appears more as its
creditor than as its owner.

The separation of the business by means of its
accounts is the essential contribution of double-entry
bookkeeping, and is often stated to be so. Particularly
happy is Goi^crg's phrasing, which I again use: En
organisant la aomptahilite d'u?ie entreprise quetconque j
on ne pour suit pas le but de detevmimr le vevenu de
son pvoprietaive 3 du capitatiste lui-rneme , qui peat avoir
des gains et dss pertes provenant des sources etrangeres
a I'entreprise en question; rnais on veut raisonner sur
I'avantage de I ' exploitation de I'entreprise donnee.

(p. eeS

II 'n.e f'aut done pas aonfondre I 'entreprise avee
le capitaliste J so7i proprietaire . Ces deux sont separes
par la aomptahilite j qui aonsidere le proprietaire de
t 'entrepriss comrr.e une personne tierae, comme son oreanoier
pour le capital qu'il lui a remis.

"Entrepreneur and enterprise are separated from,
each other by double-entry bookkeeping": that is the
kernel of the matter. [Sombart considers tb.e juridical
aspects of this separation.]

- 258 -

[Sombart examines the etymological origins of the word
Firma (firm) and its Italian counterpart, Ragione . The
Latin r-atio meant "account" as in Cicero: par est ratio
aaoeptorum et datorum.]

This etymology is no more than a welcome
confirmation of the view represented here: that book-
keeping produced the concept of the independent business
and that the capitalistic undertaking developed from
this accounting entity.

The very illuminating close relationship between
the development of the legal concept of the firm and
the development of accounting appears to be also demon-
strable with reference to the wide dissemination of a
legal rule attributable to Bartolus: in deciding ques-
tions of liability, the court may examine the business
books of account. This view was confirmed by all sub-
sequent Roman law jurists, including those of the 16th
century. This practice meant that lega], opinion neces-
sarily kept step with bookkeeping practice, and was
materially aided thereby in arriving at the concept of
the independent business.

3. The growth of systematia huainess management . —
We have up to now traced the development of the
system of double-entry bookkeeping, and established that
it was essentially completed by the beginning of the
16th century, but that certain complemeJitary details were
probably not introduced before the end of the early
capitalist period. From this, however, we know nothing
about its application in practice. We would particu-
larly like to have information on this question: to what
extent, and hov; thoroughly, did business management
operate, during the last centuries of the early capitalist
period, in conformity with the teaching and instructions
of business theorists?

We could only give a definitive answer to this
question if we had statistical data concerning the books
of account actually kept by businessmen. These we do
not possess. We cannot even find enough typical examples
of bookkeeping practice to infer from them the general
state of bookkeeping in their time. Most of the business
account books V7hich have survived belong to the 15th
and 16th centuries — perhaps two dozen in all — and 17th
and 18th century account books have been made available
until nov; in extremely small numbers.

- 259 -

So for the time being, until more authentic source
materials are supplied to us — and it is hoped that business
historians will soon make good the omission — we must rely
on interpreting signs in order to decide on businessmen's
knowledge of the art of business management and its appli-
cation in the new capitalistic undertakings.

The picture which emerges from carefully examining
the evidence is somewhat as follows: the fact that most
of the well-kept account books known to us from the 14th
and 15th centuries are Italian is certainly no accidental
result of research into business history; Italy was at
that time, without any doubt the leading mercantile
community. We need only compare the Italian account
books of those centuries with contemporary German examples
in order to determine the disparity between these two
countries. Generally, the Italian mind was further along
the road to rationalization and mechanization. We can
see hov7 the modern state began to take shape in Ital.y
in the Middle Ages. We can assume that a taste for the
exact and calculating mind took deeper and deeper root
in Renaissance man. Recall that the beginnings of land
surveying and town planning can be traced to the Italian
republics in the 14th century, that statistical method
began to take shape there, that official measurements of
time made tremendous steps forward in this period.

The history of m^easuring time and the growth of
the use of clocks provides us with evidence of the variety
of causes underlying modern life. l^ile the precise
division of time, which undoubtedly influenced rational-
ization, was originally the exclusive achievement of the
religious ccmm.unity — in the Middle Ages it V7as necessary
to measure time and divide it up only in the monasteries,
which alone had clocks, had to have cJ.ocks — ^the modern
division of time (into equal equinoctial hours) which
permitted complete rationality, in contrast to the church
and monastic division of time (into canonical hours, that
is the variable hours of antiquity) was the v;ork of modern
princes. It was they who, set upon achieving improvements
in city adm.inistration, particularly in Italy, v;anted
public striking clocks, which were invented at the be-
ginning of the 14th century, and striking clocks were
only possible if the day was divided into equal hours.
Thus, the invention led to a change in mental attitudes;
striking clocks, and v;ith them the modern m.ethod of
dividing up time , v/ere imposed by the laity upon the churches

- 260 -

and monasteries, on which (because the church tower was
usually the best place to put them) they first appeared.

[Sombart lists the places where clock towers appeared in
the 14th century, with dates.]

We are particularly interested in seeing how the
art of accounting developed and expanded. This v;ill
serve on the one hand as an expression of the general
attitude of businessmen, and on the other hand, as a
thermometer for measuring the state of business manage-
ment techniques, which resulted from the combination of
bookkeeping and commercial arithmetic. These were
separate subjects, so that the development of accounting
required a simiultaneous development of commercial arith-
metic and its dissemination among businessmen, which
must have taken place through school instruction. It
is therefore iraportant to establish that in Italy, at
a relatively early date, i.e., by the 14th century,
arithmetic was taught in schools. Giov. Villani informs
us that in Florence in 1340, 8-10,000 boys and girls were
learning to read, and 1,000 to 1,200 boys in six schools
were learning arithmetic.

[Sombart provides the bibliographical references and
discusses the authenticity of the estimates.]

In Paris there were also numerous primary schools
i-n the Middle Ages , which were attended by several
thousand pupils in the 15th century.

What did they learn in arithmetic lessons? We
can answer: essentially the contents of the Liter ahaeoi
of Leonardo of Pisa. This book taught the four basic
operations underlying comiriercial arithmetic, and also
the rule of three, and contained a large quantity of ex-
amples concerning matters of interest to businessmen:
weights, coinage, dimensions, exchange equivalents, etc.

[Sombart lists the relevant chapters.]

To this the following centuries saw the addition
of the abacus, and in Italy in the 15th century pupils
were already being taught interest and discount calcu-
lations. About the and of the century, the final version
of the rule of three made its appearance.

261 -

We must beware of drav/ing exaggerated conclusions
concerning the level of businessmen's education from the
level of the extensive and intensive development of arith-
metic and systematic business management at the time.
Even in Italy, throughout the entire Middle Ages and later
well into the period of early capitalism, patriarchal
systems flourished, even in large businesses. We know a
great deal about the clans and their thoroughly uncapi-
talistic business administration. Even the manner in which
the books were kept was often rough and ready. The books
of the Soranzo and the Barbarigo are full of inaccuracies,
discrepancies, obscurities. It appears to have been the
exception to have a well-kept set of books. According
to bookkeeping experts, such an exception is provided by
the account books of Giac. Badoer. (G. Brambilla, Stovia
della ragioneria I tali ana , (1901) pp. 55 et seq.)

Sometiiries anecdotes provide the best picture of
the general attitude or style of a period. Thus, I would
like to introduce here a few words from, the family records
of the Albertis which appear to me to throw light on
conditions in the business comraunity of Florence during
the late Middle Ages.

Leon Battista recounts:

Maestro Benedetti Alberti was fond of saying: it
suits the efficient businessman to have ink always on his
£ingers , He explained that it is the duty of every mer-
chant, as indeed, of every businessman who has transactions
with many people, to write everything down, every contract,
every receipt and every payment, and to check so often,
that he seems always to have pen in hand.

From this anecdote v/e learn:

1. that it v7as not a universal custom among the
business community of Florence to keep books.

2. that the head of a "v7orld-wide" trading concern
kept his books himself, at least in part.

3. that he was as clumsy as a schoolboy who \>:rites
with ink for the first time, and gets it on his
fingers.

This picture is confirmed when we learn that
Domenico Man:^oni, who re-worked Pacioli ' s chapters on

- 262

bookkeeping and amplified them with numerous examples, had
a collection of twelve lettering models in his mercantile
library, in the year 1564.

We must also remember that the Arabic numerals
introduced by Leonardo of Pisa had to fight a lengthy
battle before they overcam.e. I recall that even in 1299,
the use of Arabic numerals was forbidden. As late as
the 16th century we can still find Latin numerals used in
theoretical works on bookkeeping as well as in many
Italian books of account. It has been correctly pointed
out that Latin numerals did not render double-entry book-
keeping impossible, but it cannot be denied that they
placed severe restrictions on the free evolution of the
principles of accounting and on accountability in general.

If, then, we see in Italy only a slow dissemination
of systematic (i.e., capitalistic) business management,
it will be well to place its beginning and growth in other
countries appreciably later in time. We know that in
the 16th century German merchants were still learning
arithmetic in the Italian cities; they even brought book-
keeping a la Venezia back with them. But these are merely
particular cases. Knowledge became more general when
German writers published books on double-entry bookkeeping
and the related commercial arithmetic. This took place
during the 16th century. But the first works of this kind
to appear in Germany, such as those of Magister Henricus
Grarnmateus (1518), of Joann Gottlieb (1531) etc., are well
behind Luca Pacioli in their system.ization . Only gradually
were the heights of the Italian theory attained and its
application was correspondingly slow. Account books of
the 16th and 17th centuries provide evidence of our halting
development of business accounting. Adam Riese's country
seems, however, to have taken over the leadership in this
field of learning in the 16th century.

In the other countries north of the Alps, the new
system, of bookkeeping and commercial arithmetic made slov;
but steady progress.

The books of Andr. Ryff (end of the 16th century)
and the account books of Froben and Episkopius show that
double-entry bookkeeping was as yet unknov;n in Sv/itzerland.
Ryff admits that his agents, and the necessity to settle
accounts with them periodically, imposed upon him the need
to keep books rigorously. On the other hand, Geering

- 263 -

asserts that by the beginning of the 17th century, all
large trading concerns in Switzerland kept their books in
the Italian style.

In England, the first author of a text on double-
entry bookkeeping was Hugh Oldcastle (1543) . But James
Peele, in the preface to his 1569 book on accounting,
remarked that the art was new in England and that business-
men and their apprentices took lessons from him.

At any rate, throughout the 16th century business
life in England was also virtually untouched by these
changes. We find in the books, even of the great trading
companies of the time, a quite medieval and artisanal
type of record-keeping. Improvement is noticeable at the
beginning of the 17th century; for example, the concept
of capital enters into the books of account, doubtless
under the influence of those merchants who came into con-
tact V7ith Italians, as members of the Levant Company.

What som.e bookkeeping conditions were like even
at the beginning of the 18th century can be seen from the
follov/ing story: Zetner of Strasburg was invited to
England by an industrialist "who had a large manufactory
of woollen goods in Exeter, to obtain an accounting from
the manager of the factory, who had nob submitted one
for twenty years" {Zetners Reiss journal , E, Reuss (1912)
p. 75) .

The new art first found entry into Holland and
France through a translation of Luca Pacoli into Flemish
and French, by Jan Ympyn (154 3) .

Holland developed its own culture in the field
of bookkeeping theory and practice. The path-breaking
bookkeeping v;orks of the northern Netherlands v;ere the
1583 publication by Nicolaas Petri Van Deventer, Pvactique
om te leeren reeekenerij ayphersn ende boekhuden (met die
Reget ooss) ende geometvie , seer ■profitetyaken voor alle
aoopluyden-j and in 1588, Boeckhouden op de Italiaensahe
maniere . The best known Dutch teacher of this subject is
Simon Stevin, whose Hypomnemata Mathematiaa appeared in
1605-8 as an aid to the Prince of Nassau's educational
schemes .

In the 17th century, more than 60 books on accounting
were published in the Dutch language. [Sombart notes that

264 -

the growth of foreign exchange banking and currency
arbitrage in Kolland stimulated interest in bookkeeping,
in order to be able quickly and accurately to calculate
profit or loss. The Dutch produced specialist tests on
this subject before anyone else.]

Leadership in coitimercial arithmetic, which certainly
lay in Italy at the start, was now taken over by Holland.
Holland was the exemplar, not only for all middle-class
virtues, but also for arithmetical precision. In the 18th
century for example, the discrepancy between the American
and Dutch arts of commerce was noticed. Benjamin Franklin
tells the story of the widow of one of his associates, a
Dutch woman by birth; how she sent him regular and exact
accounts which her husband (an American) when alive, never
did. "... the knowledge of accounts" he adds, "makes
a part of female education" in Holland [Memoir, I, p. 150
(1833)].

From what we know of French account books of the
16th and 17th centuries, the state of the art of book-
keeping there was extremely variable; the number and types
of books of account differ from case to case.

[S. mentions French sources, one of which
(Maillefer) acknovrledged double-entry as a novelty in the
middle of the 17th century.]

In the 17th century, hov;ever, France apparently
b'ecame, with Kolland, the country in which commercial
arithmetic reached an unusual degree of advancement. [In
a note, S. complains of the absence of decisive evidence
and hopes that his efforts will stimulate historical re-
search in this area.] We may conclude this from the
unusually large number of excellent "businessmen's books"
in the French language, such as the Savarys ' , the two
Ricards", and so on.

We may also take as a sign of highly developed
business techniques the fact that France was the first
country in Europe to enact legislation urging every
businessman — -wholesale as well as retail — to keep books of
account.

The Ordonnance of 1673, Title III, Article I,
states: Les negociants et marchands tant en gros qu ' en
deta-il auTont un L-ivve qui eontiendva tout leuv 'Segooe,
leurs lettres de change, teurs dettes aatives et passives ,
et les deniers employes a la depenses de leuv maison.

- 265 -

They were admonished, not obliged. L ' Ovdonnance
enjoigne aux Mavahands et Negooians d' avoir des Livres
SUV les quels its eoriront toutes leurs affairesj
neansmoines its ne sevont point fovcez d'en avoir-, oeZa
de-pendra de teuv volonte. There was only an indirect
element of force in that an accusation of fraudulent
bankruptcy could be refuted with books of account. Thus
comments Savary, father of the Ordonnance {Le par fait
negoaiantj I, p. 248).

To be legally recognized, books of account had to
be certified by a consul or mayor. Les livres des Negooians
et Marahands tant en gros qu'en detail, seront signes sur
te premier et der-yiier feuillet, par I'un des Consuls dans
les villes ou il y a jurisdiction aonsulaire et dans les
autres par le ma.ire ou I 'un des Eahevins , sans frai ni
droits, et les feuillets paraphes et cottes par premier
et dernier de la main de aeux qui auront ete aommis par
les Consuls ou maire et echevins , dont sera fait mention
au premier feuillet (Article II, line 3).

These provisions undoubtedly represent a step
forv/ard in the direction of organized business management,
which however already existed in France, since before the
Ordonnanoe of 1673 it was the custom for wholesalers tc
keep books of accounts, as Savary assures us {Le parfait
negociant, I, p. 249).

Again, we must recall that we refer only to the
beginnings of accounting. For what the Ordonnanoe calls
for, and what Savary found to be "nothing new" in France,
was a simple journal, in which all business transactions
were set down in chronological order. Of course, some
businesses also kept double-entry books; but certai.nly
not the majority.

Did England then become, not only the greatest
trading nation, but also the most advanced country in
business management techniques? We do know that at the
beginning of the 19th century, German businessmen looked
to Holland and England as the countries of advanced
commercial training, which at that time appears to have
reached its apogee within Germany in the city of Hamburg.
One knov/ledgeable observer of the 1830s wrote the following
words on the relationship of these countries to each
other:

- 266 -

To such free and clear views of business affairs as
have Englishmen, businessmen through and through, the
Hamburger arrives rarely, or late; that decisiveness,
independence which the former displays, the latter
is almost completely lacking in this connection. In
spite of this, one can hold up the commercial accuracy
of the Hamburger as an example to the rest of Germany;
it is almost equal to that of the Dutch, although
significantly more generous than the fearful Mynheer
(Lud. Schleicher, das mevkantilische Hamburg (1838)
p. 75) .

Hamburg did most in the 18th century for the
cultivation of the arts of business, of which Joh. Biisch
was the outstanding representative.

If we survey the entire period of early capitalism
we arrive at the conviction that throughout the whole of
Europe, business techniques began to be based on new
principles, that everywhere and in consequence of this,
capitalistic enterprises arose, but that in no case before
the second half of the 17th century had more than a small
proportion of firms taken the steps which led away from
unsystematized and highly personalized management, so
that the general type of business, even in the last cen-
turies of early capitalism, represents a transitional
phenomenon. V7e shall be confirmed in this viewpoint when,
in the following chapter, we study the development- of
capitalist forms of business enterprise ^

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BIOGRAPHICAL SKETCH

Kenneth S. Most was born on February 4, 1924, in
Leeds, England. After serving articles (apprenticeship)
with a public accountant, he qualified by examination as
a Chartered Accountant in 1946, and was admitted to the
English Institute of Chartered Accountants, first as an
Associate and, from 19 60, as a Fellow. After twenty years
as an auditor and financial consultant, during which period
he graduated Bachelor of Laws as an external student of
London University, he joined the London Polytechnic in its
School of Management Studies (1960) , where he taught finance
and accounting for four years. In 1964 he became Head of
the School of Accounting in the Singapore Polytechnic,
later in the University of Singapore. Since 1967 he has
pursued work at the University of Florida for the Degrees
of Master of Arts with a major in Accounting (1958) and
Doctor of Philosophy with a major in Economics.

He was a Simon Research Fellov; in the Department of
Economics of the University of Manchester during the session
1958-59, and has been visiting professor at a number of
European schools of business administration. At the
University of Florida he has taught both accounting and
finance; he was av/arded an Earhart Foundation Scholarship

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for 1968-69 and 1969-70, and elected to Phi Kappa Phi
and Beta Alpha Psi.

Mr. Most has written several books and many
articles on accounting and finance. He is married and
has three children.

This dissertation was prepared under the direction
of the chairman of the candidate's supervisory committee
and has been approved by all members of that coirimittee. It
was submitted to the Dean of the College of Business Adm.in-
istration and to the Graduate Council, and was approved as
partial fulfillment of the requirements for the degree of
Doctor of Philosophy.

June, 1970

Administration

Dean, Graduate School

Supervisory Coirimittee;

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